Assign#02

International Economics – Assignment # 02 CH: 2 Gains and Losses from trade in “The Specific-Factors Model”

Problem 3 Part a A fall in the relative price of manufacture is the same as a rice in the relative price of agriculture. First of all, the world price line (-PM/PA)w will have a flatter slope than pre-trade slope is -PM/PA

In other words just recreate figure 3-4, but with the world price line less steep than the price line of the country in isolation (pre-trade situation). The point at which the world price line is tangent to the production possibilities frontier should then be to the left (less manufacturing output) of the no-trade equilibrium. Production of manufactures therefore decreases while agricultural production increases. The world price line should be tangent to an indifference curve corresponding to a higher level of utility than U1 . The point at which these two curves are tangent defines consumption.

Part b Consumption exceeds production in manufacturing, while production exceeds consumption in agriculture. Therefore, agricultural goods are exported (not surprising as agricultural goods are relatively more expensive on the world market).

Part c The gains from trade come from comparative advantage, which also exists in this case (it is unimportant that the comparative advantage is in the production of different goods).

Problem 4 Part a The diagram should resemble figure 3-6, but with a downward shift in the curve. The relationship between wages and the price of manufactures can be inferred directly from the diagram. The price of manufacture good falls so wages falls from W’ to W.

From this figure one can see that the vertical fall, orange pile

is bigger than

the fall in wage red pile. The real wage of labor in terms of manufacture increase due to that the percentage price fall is bigger than the percentage wage decrease.

Part b The real wage redefines the wage in terms of the amount of goods or services that it could be used to purchase, in this case W/PA. The price of agricultural goods does not change, while the nominal wage decreases, so the real wage defined in terms of the agricultural good decreases. In other words: The real wage of labor in terms of agriculture is decreasing since the price of agricultural is unchanged and wage falls.

Part c As real wages increase in terms of one good but decrease in terms of the other, so without making further assumptions about utility it is unclear whether workers are made better or worse off. In other words: Workers outcome are ambiguous. We can not say if they are better or worse off since that depend on preferences of consumption. If one normally consumes more of manufacture goods than agricultural they are better off, but if one normally consumes more of agricultural goods they are worse off.

Problem 5 Part a The impact on land:

Part b The impact on rental to land are bigger than both the wage increase and price increase of agricultural good.

This means that in real terms the return to land has increased in both goods and since price are constant in manufacture and wages are equalized across both sectors (i.e. increased in both sectors) the return to capital has decreased.

In other words: The question defines

a general price increase of between 0% and 10% (the best we can say without making any assumptions about the utility function). The changes in the nominal rentals on capital and land both lie outside this range, so it is possible to infer the sign of the change in the real rental on each factor.

Problem 6 The price of manufacture falls by 10%:

the impact is that wage falls but less than the percentage fall of prices in manufacture, the rental on capital (which is specific to manufacture) falls by more than the manufacture price so the capital owners are worse off than in the situation in question 5. The impact on land s that since wages are equalized in both sectors they will have lower wage costs but at the same agricultural price, so the return to land are positive and they are better off. The impact on labor is that the nominal wage falls, but real wage in terms of manufacture are increasing and the real wage in terms of agricultural are decreasing. More labor will work in agriculture, but the real wage outcomes are ambiguous.

Problem 9 Canada and Mexico, timber (=agricultural, land specific) and TV(=manufacture, capital specific) and labor (mobile factor).

Part a In Canada the relative price of TV falls shifts the demand for manufacture line down. Wages decrease, labor moves to agricultural (timber). From this figure the percentage price fall of TV (manufacture good) is bigger than the wage fall (the percentage change in wage are between the percentage changes in both goods, means changes less than TV but more than timber). This

means that real wage in terms of TV increase. Real wages in terms of timber (agricultural) decrease.

Part b The impact on rental to land are that they gain; lower wage costs but same prices. The impact on rental to capital are that they lose from opening to trade; wages decrease and prices decrease even more. In real terms land gains in both goods and capital lose in both. Alternatively: In Canada, the drop in the price of televisions leads to a decrease in production and a decrease in the rental on the factor used by that industry. The effects on the timber industry are in the opposite direction. For each good, the percentage change in nominal returns for the specific factor is large relative to the percentage change in the price of the good. It is therefore possible to sign the change in the real rental on each factor.

Part c The interpretations for Mexico are analogous to those in part b, of course with the industries and factors reversed. In other words:

In Mexico the relative price of timber falls, shifts the demand for agricultural line to the right. Wages decrease, labor moves to manufacture (TV). From this figure the percentage price fall of timber (agricultural good) is bigger than the wage fall (the percentage change in wage are between the percentage changes in both goods, means changes less than timber but more than TV). This means that real wage in terms of timber increase. Real wages in terms of TV (manufacture) decrease.

The impact on rental to capital are that they gain from opening to trade; lower wage costs but same prices. The impact on rental to land are that they lose; wages decrease and prices decrease even more. In real terms capital gains in both goods and land lose in both.

Part d See parts b and c, this is simply a matter of identifying the exporting industry in each case. In other words: The specific factor in export industry has gained from trade ( in Canada timber are exported and land gains; in Mexico TV are exported and capital gains), and the specific factor in import industry has lost from trade (in Canada TV are imported and capital lose; in Mexico timber are imported and land lose).

Problem 10 Part a Computer (capital specific) and wheat (land specific) and labor are mobile. The relationship between output of wheat and marginal production of labor in wheat industry is diminishing return. The first unit of labor has a high marginal production but the last unit of labor has a lower marginal production. The relation is that more labor increase output but at diminishing rate.

Part b In Home if we assume that one labor, one unit of land and one unit of capital are productive one to one we get these intercepts.

Part c In absence of trade the price of wheat relative to computers are determined by the slope of the production possibility frontier (PPF). The slope is interpreted by the opportunity cost of producing one more unit of wheat in terms of the amount of cars that one would need to give up. This comes from the assumption that labor are free to move and therefore in equilibrium wages are equalized in both sectors. This is the wage condition: PW∙MPLW = Wage = PC∙MPLC and by rearranging in equilibrium we get that relative price of wheat equals the opportunity cost of wheat: PW/PC= MPLC /MPLW.

Part d & e

The price of wheat increase to PW’, the nominal wages increase. Real wage in terms of cars increase and decreases in terms of wheat. The allocation of labor is that more are working in wheat than in cars industry.

Problem 11 Part a Consider once again that the marginal cost of labour must equal the marginal productivity of labour in a competitive market:

As labour is mobile between industries, the wage must be uniform within each country. Furthermore, as Foreign is relatively abundant in land, its marginal product of labour in the production of wheat is relatively high. Using the equality between the marginal cost and product of labour, we can then infer which country has a higher no-trade relative price of wheat. In other words: Foreign has the same amount of labor, more units of land but less units of capital than home. If we assume that all workers are productive 1 to 1 in both countries the relative price of wheat will

be higher in home than in foreign. The slope of the price line in these figures shows higher relative price in home (steeper slope) than in foreign.

Part b When trade is opened, the relative prices must converge to a level between the no-trade relative prices in the two countries. From this it is straightforward to infer the direction of the change in each country. In other words: When trade is open the world relative price is always between the both lands relative prices. This means that the relative price of wheat in home will decrease and the relative price of wheat will increase in foreign. PW*/PC* < PWW/PCW < PW/PC

Part c The rental to land is specific to wheat and will increase in foreign (where wheat is exported) and the rental to land will decrease in home (where wheat in imported). The rental to capital, specific to computers, is the reverse: increase in home (where computers are exported) and decreases in foreign (where computers are imported). In other words: When trade is opened the rental on the factor used in the industry that begins to export will increase, while the rental on the factor used in the industry that begins to import will decrease.