Salvatore’s Introduction to International Economics, 3rd Edition

*CHAPTER 3
(Core Chapter)
THE STANDARD TRADE MODEL
ANSWERS TO REVIEW PROBLEMS AND QUESTIONS

1. a. Increasing opportunity costs arise because resources or factors of production are not
homogeneous (i.e., all units of the same factor are not identical or of the same quality) and
not used in the same fixed proportion or intensity in the production of all commodities.
This means that as the nation produces more of a commodity, it must utilize resources
that
become progressively less efficient or less suited for the production of that
commodity. As
a result, the nation must give up more and more of the second commodity to release just
enough resources to produce each additional unit of the first commodity (i.e., it faces
increasing costs).

b. In the real world, the production frontiers of different nations will usually differ because of
differences in factor endowments and technology.

2. a. See Figure 1 on the next page.

b. The slope of the transformation curve increases as the nation produces more of X and
decreases as the nation produces more of Y. These reflect increasing opportunity costs as
the nation produces more of X or Y.

3. a. See Figure 2.
b. Nation 1 has a comparative advantage in X and Nation 2 in Y.
c. If the relative commodity price line in autarky has equal slope in both nations. This is rare.

4. a. See Figure 3. Points B and B’ are the production points in Nations 1 and 2, respectively, with
specialization and trade and E and E’ are the consumption points.

b. Nation 1 gains by the amount by which community indifference curve III (point E) is
above
indifference curve I (point A). Nation 2 gains to the extent that community indifference
curve
III’ (point E’) is above indifference curve I’ (point A).

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Salvatore’s Introduction to International Economics, 3rd Edition

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Salvatore’s Introduction to International Economics, 3rd Edition

5. a. The equilibrium-relative commodity price in isolation is the relative price that prevails in
the nation without trade or in autarky.

b. The equilibrium-relative commodity price in isolation for the commodity plotted along the
horizontal axis is given by the (absolute) slope of the tangent of the production
frontier and
the community indifference curve at the point of production and consumption in the
nation
in isolation.

c. The nation with the lower equilibrium relative commodity price in isolation or autarky has
a comparative advantage in the commodity measured along the commodity axis and a
comparative disadvantage in the commodity measured along the vertical axis.

6. See Figure 4 on the next page.

Supply curve AFB for commodity X in Nation 1 (SX) in the left bottom panel is derived
From production points AFB, respectively, at PA (not shown in the figure) < PF < PB on the
production frontier of Nation 1 in the top panel. Nation 1’s demand curve AHE in the left
bottom panel (DX) is derived, respectively, from tangency points of community indifferences
and trade lines at points A, H and E in the top panel. SX and DX for Nation 2 in the right
panel are derived in an analogous way.

From both bottom panels, we see that only at PB = PB’ would the quantity of exports of
commodity X supplied by Nation 1 exactly match the quantity demanded of imports of
commodity X of Nation 2. Thus, PB = PB’ is the equilibrium relative commodity prices with
trade.

7. a. The reason for incomplete specialization under increasing costs is that as each nation
specializes in the production of the commodity of its comparative advantage, the relative
commodity price in each nation moves toward each other (i.e., become less unequal)
until
they are identical in both nations. At that point, it does not pay for either nation to
continue
to expand the production of the commodity of its initial comparative advantage. This occurs
before either nation has completely specialized in production.

b. Under constant costs, each nation specializes completely in production of the commodity of
its comparative advantage (i.e., produces only that commodity). The reason is that since it
pays for the nation to obtain some of the commodity of its comparative disadvantage
from
the other nation, then it pays for the nation to get all of the commodity of its
comparative
disadvantage from the other nation (i.e., to specialize completely in the production of the
commodity of its comparative advantage).

8. See Figure 5.

Nations 1 and 2 have identical production frontiers (shown by a single curve) but different
tastes (indifference curves). In isolation, Nation 1 produces and consumes at point A and

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Salvatore’s Introduction to International Economics, 3rd Edition

Nation 2 at point A’. Since PA < PA’, Nation 1 has a comparative advantage in X and Nation 2 in Y.

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Salvatore’s Introduction to International Economics, 3rd Edition

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Salvatore’s Introduction to International Economics, 3rd Edition

With trade, Nation 1 specializes in the production of X and produces at B, while Nation 2
specializes in Y and produces at B’ (which coincides with B). By exchanging BC = B’C’ of X
for CE = C’E of Y with each other (see trade triangles BCE and B’C’E’), Nation 1 ends up
consuming at E on indifference curve III (higher than indifference curve I at point A) and
Nation 2 consumes at on indifference curve III’ (higher than indifference curve I’ at point A’).

9. a. If the terms of trade of a nation improved from 100 to 110 over a given period of time,
the terms of trade of the trade partner would deteriorate by about 9 percent over the same
period of time [(100-110)/110 = -0.09 = 9%].

b. A deterioration in the terms of trade of the trade partner can be said to be unfavorable to the
trade partner because the trade partner must pay a higher price for its imports in terms of
its exports.

c. This does not necessarily mean that the welfare of the trade partner has decreased because
the deterioration in its terms of trade may have resulted from an increase in productivity
that is shared with the other nation.

10. It is true that Mexico's wages are much lower than U.S. wages (they are about one fifth of the
average wage in the United States), but labor productivity is much higher in the United
States
and so labor costs are not necessarily higher than in Mexico. In any event, trade can still be
based on comparative advantage.

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