Martin Finet

Raphaël Mir

Problem Set : International trade

Exercise 1 :
a) Australia has an absolute advantage in the production of cars while Canada has an absolute ad-
vantage in the production of ships. Indeed, Australia only needs 25 workers to produce one car
while it takes, 50 workers for Canada and 200 workers for Japan to get the same result. Thus, Aus-
tralia has an absolute advantage in the production of cars because it has a higher productivity. The
same goes for Canada and the production of ships.

b)
Numbers of output for Japan Canada Australia
1 worker
Ships 1/400 1/50 1/100
Cars 1/200 1/50 1/25

Unit cost in workers Japan Canada Australia

Ships 400 50 100
Cars 200 50 25

1
For the Japan : One ship takes 400 workers. Thus, 400 workers could make × 400=2 cars in Ja-
200
pan. Thus, in Japan, the opportunity cost of ships is 2 cars. Following the same pattern, we get the
following table.

Opportunity cost Japan Canada Australia

Ships 2 cars 1 car 4 cars
Cars 1/2 ship 1 ship 1/4 ship

c) Thus, Australia has a comparative advantage in cars and Canada has a comparative advantage in
ships. Indeed, Australia has a comparative advantage in cars because its opportunity cost in building
cars is lower than any other countries (1/4 ships against 1 in Canada and 1/2 in Japan). Following
the same reasoning, Canada has a comparative advantage in cars.

d) Relative prices (unit cost in workers of ships/unit cost in workers of cars) for each countries :

Japan : 400/200 = 2
Canada : 1
Australia : 4

Thus, if world relative price has settled at 2.5, as 1<2.5<4, Canada and Australia will specialize to-
tally in the production of the goods where they have a comparative advantage. Indeed, Canada’s re-
lative price if strictly inferior to world’s relative price and Australia’s relative price is strictly super-
Martin Finet
Raphaël Mir
ior to world’s relative price. This means that Canada has an interest in producing ships and selling
them, because ships are more costly in the rest of the world than in Canada. This is the same mecha-
nism for Australia and cars. Thus Canada will only product ships and Australia will only product
cars.
Canada will therefore export ships and Australia will export cars.
Moreover, as Japan’s relative price (2) is inferior to the world’s relative price (2,5), this means that
it is still worthy to export ships are their domestic relative price is inferior to the world relative
price. Yet, as Japan as no comparative advantage, it will product both goods, but will only export
ships.

e) If Australia is in autarky, it closes to trade. Thus, it leaves us to the following table.

Opportunity cost Japan Canada
Ships 2 cars 1 car
Cars 1/2 ships 1 ship

It appears that, from this point on, Japan has a comparative advantage on ships and Canada has a
comparative advantage on cars.

Thus, Japan will cease to produce cars and will only produce ships, which it will also export. Cana-
da will continue to produce and export only cars.

Exercice 2

(a) We could expect China to be relatively labor-abundant and Japan to be relatively capital-
abundant. Indeed, the labor intensity L/K of China should be superior because of its mas-
sive population. In contrast, Japan has a more limited demographic weight. Their develop-
ment largely relies on capital.
(b) The cloth industry should be more relatively more labor-intensive than the car industry,
which should be relatively more capital-intensive. Indeed, the production of cars is more
likely to rely on the use of machines and technology more importantly.
(c) See graphs below.
Martin Finet
Raphaël Mir
The first questions conducted us to assume that the car industry was more capital-intensive and
Japan more capital-abundant. Indifferent curves have the same shape since preferences are the
same in both countries. The production possibility frontier has a different shape in both countries
because of these differences. These graphs show that Japan will thus produce more cars and less
clothes than China because of these relative differences. If we follow the conclusions of the HOS
model, Japan should specialize in the production of cars because it is relatively more capital-abun -
dant and the car industry more capital-intensive and China will specialize in clothes for the oppo-
site reason.

Research Paper :

2- Regional effects of trade reform: What is the correct measure of liberalization? - Kovak (2013)

Motivation of the article and methodology

As international trade has become a very important component of economic research and life, this
article published by Brian Kovak in the American Economic Review tries to examine the local effect
of liberalization through changes in local wages. The author uses a specific-factors model of re-
gional economies. This model conducts the author to make a series of assumptions: mobility of la-
bor between industries, immobility between regions, inelasticity and full use; immobility between
industries and regions of a second input that represents fixed characteristics of a region that increase
the productivity of labor in the relevant industry. He chooses to integrate the prices of nontraded
sector in his analysis. This inclusion reveals that nontraded prices move with traded prices. The data
used comes from the Brazilian Demographic Censuses for 1991 and 2000. He chose to focus on the
example of the trade liberalization of Brazil in the early 1990s. The study of the Brazilian case is
particularly interesting because they shifted from a policy of import substituting industrialization to
a liberal trade policy around March 1990 following a balance of payments crisis. The measure of
trade liberalization is based on the 1990-1995 proportional change in one plus the tariff rate. The
author is able to identify a causal effect since there is no correlation between tariff changes and in-
dustry performance in the case of Brazil (it appears as an exogenous decision of the government).
Moreover, the policy conducted aimed at equalizing the tariffs between regions and industries.
Thus, it is possible to study different extent of tariff cuts.

Indeed, the author carried out empirical studies on the effect of various alternative regional mea-
sures of liberalization on wages. After having neutralized the effect of individual characteristics on
wages in each Brazilian microregion, the author was able to measure trade liberalization’s effect on
a region’s wages, which is determined by a weighted average of liberalization-induced price
changes, what he called the “region-level tariff change” (RTC). He first calculated the RTC for each
micro region. This calculation brings to light huge differences in RTC between the Brazilian micro-
region. Then, the author could sort the industries from the most negative to most positive tariff-
change comparing the weight of those industries within the most impacted microregion (Rio de Ja-
neiro, with the most negative region-level tariff change, and Traipu in the state of Alagoas, the most
positive region-level tariff change). It came out that agriculture was the industry with the most posi-
Martin Finet
Raphaël Mir
tive tariff change. Having empirical estimation of the regional wage changes and region-level tariff
changes, it is possible to examine the effect of tariff changes on regional wages. Following the mo-
del previously developed, the author formed estimating equation measuring the regional effect of
liberalization on real wages between 1991 and 2000 taking into account some potential bias such as
Brazilian’s mobility and an imperfect pass-through from tariff changes to price changes. Following
that regression, the author came to the conclusion that the relation between wage changes and re-
gion-level tariff changes was positive. As he predicted in his model, he empirically showed that mi-
croregions facing the largest tariff declines experienced slower wage growth than regions facing
smaller tariff cuts.

To conclude, Brian Novak developed a model able to measure the effect of liberalization on regio-
nal wages, at least in the case of Brazil. It shows that local labor markets facing wide tariff cuts will
be more negatively affected than markets facing smaller cuts, which may be positively affected.
From a methodology view point, this paper gives a guide to construct a local measure of liberaliza-
tion as well as a theoretical basis to empirical approaches of the local effects of liberalization. Final-
ly, the author opens the door to research on the effects of liberalization on inequalities.