Economic Policy 1 Problem Set
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Economic Policy 1 Problem Set
True / False / Uncertain (28 points). For each of the following statements, tell me ifthe statement is true, false or uncertain and explain why using words, figures, or both. Note: the explanation is more important than the answer! Please try to restrict your answer to each part (e.g., part a) within roughly 100 words.
a. (7 points) According to the Ricardian model, the United States will be worse off if productivity levels rise in China.
b. (7 points) According to the Ricardian model, an increase in the population of a country will not change the country’s comparative advantage or real wages.
c. (7 points) In the Ricardian model, since absolute advantage is irrelevant for the gains
from trade, Chile, a developing country, would be indifferent between signing a free trade agreement with Germany (a developed country with high levels of technology) or with Argentina (a developing country with low levels oftechnology).
d. (7 points). In the specific factors model, capital, the immobile factor will always resist signing free trade agreements.
Understanding Ricardo
Country A has 120 units of labor available, while country B has 240 units available. Each country can produce two goods. The table lists the respective unit labor requirements, i.e., the number ofunits of labor it takes to produce one unit of output.
Country Food Clothing Total labor
A 3 2 120
B 4 3 240
a. (2 points) Compute the output per worker of clothing and the output per worker of food in each country.
b. (2 points) Which country has an absolute advantage in clothing, and in food?
c. (5 points) Create a graph of each country’s PPF (with food on the y-axis) and indicate the equations defining each frontier. Indicate country B’s variables with a superscript *.
d. (3 points) What is the price of clothing, in terms of food, in each country?
e. (3 points) Using the previous answers, what is the pattern of trade?
f. (3 points) Assuming that trade occurs, what do we know about the equilibrium price in free trade?
g. (3 points) Show in a graph that both countries are better off with free trade.
h. (4 points) In which country would you choose to live, that is, in which country can you earn higher real wages?
Free Trade Agreement (30 points)
Assume two countries Argentina and Brazil that produce two goods, corn and wine. Assume that land is specific to corn, capital is specific to wine, and labor is free to move between the two industries. Assume that Brazil has a comparative advantage in corn, and Argentina has a comparative in wine. Brazil and Argentina sign a free trade agreement, and we want to study the consequences ofthis trade agreement.
a. (6 points). Is it possible that real wages move in opposite directions in these two countries with the trade agreement? Explain
b. (6 points) What is the impact of opening trade on the real return to capital and land in Brazil and in Argentina? Explain
c. (6 points). In each country, has the specific factor in the export industry gained or lost, and has the specific factor in the import industry gained or lost? Explain
d. (6 points) Now assume that Argentina implements a labor market reform that reduces mobility of labor across industries. Specifically, assume that labor is now a specific factor to both industries. Land is still specific to corn, and capital is still specific to wine. Can the free trade agreement with Brazil increase income inequality in Argentina with this new labor market structure? Explain.
e. (6 points) Now assume that corn is produced with labor and capital (instead of land). Moreover, Brazil and Argentina, as part ofthe agreement, implement reforms so that capital and labor become perfectly mobile across industries. Assume that wine is capital intensive relative to corn. Brazil still has comparative advantage in corn and Argentina in wine. Which group, capital owners or workers, are better off with the trade agreement in Brazil and in Argentina compared with autarky? Explain.
2022-02-09