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SEMESTER 2 EXAMINATIONS 2018-19

ECON6016 International Trade Theory and Policy

1. Consider the Ricardian model with two countries, Home and For- eign, and two goods: wine and cheese. Suppose that Foreign’s unit labour requirement in wine is ﬁve times that of Home’s unit labour requirement in wine, whereas Foreign’s unit labour requirement in cheese is three times that of Home’s unit labour requirement in cheese. Moreover, Home’s unit labour requirement in wine is equal to that for cheese. Using the necessary graphs, what can you say about absolute and comparative advantage of Home? If, after trade, both goods are being produced, what can you say about the relative price of wine Pwine /Pcheese ? What about the relative wage, w/w* ,

where w is Home’s wage and w* is Foreign’s wage. [20]

2. Consider a simple model of international labour mobility. There are two countries, one good Q and two factors of production, land T and labour L. Suppose that in country A the real wage is lower than in country B. Suppose now that labour movement is free between the two countries. Using the necessary graphs, explain what happens to the real wage of country A, its real rental rate of land, its amount of labour and the world production of good Q. Is there any empirical evidence supporting the model’s prediction on the eﬀect of labour mobility on the real wage in country A? [20]

3. Consider the Heckscher-Ohlin model. Suppose the prices of Cloth and Food are constant. Use the Edgeworth Box to analyse the eﬀects of an increase in the economy’s endowment of capital on the factor-price ratio, the capital-labour ratio, the input allocation and the production in the two sectors. [20]

4. Explain what is intra-industry and inter-industry trade. How can we explain the emergence of each type of trade? Can we have both

types simultaneously in a country and why? What is approximately the share of intra-industry trade with respect to world trade? [20]

Section B

1. Consider a model with two countries, Home and Foreign. The fol- lowing table summarises the hours of labour needed in each country to produce Food (F) and Cloth (C).

Home Foreign

Food 5 10

Cloth 10 5

(a) What is the opportunity cost of producing Cloth in terms of Food in each country? Which country has a comparative advantage in the production of Food? [5]

(b) Let PF and PC be the prices of Food and Cloth, respectively. What are the autarkic price ratios in the two countries? Draw the Production Possibility Frontier for each country, putting Cloth on the horizontal axis. Determine a range for the world price ratio that will prevail once these countries open their economies to trade. If the world price is the lowest possible, what can you say about the production of Home and Foreign? [5]

(c) Suppose that both countries are endowed with 100 units of labour. Further assume that the tastes are such that goods are consumed in ﬁxed proportions. In particular, the Foreign country likes to consume 10 units of Food for every 5 units of Cloth (at any prices), while Home likes to consume 5 units of Food for every 10 units of Cloth (at any prices). Draw the indif- ference curves for each country, putting Cloth in the horizontal axis. Draw the production possibilities curves for Home and the Foreign country. Determine the production and consumption of

each commodity under autarky (before trade). If there is free trade and the world price is = 1, what is the world supply and world demand for Cloth? [10]

2. Consider the Heckscher - Ohlin model. There are two factors of production, labour L with price w and capital K with price r. There are two goods, computers C, whose production is capital intensive and shoes S, whose production is labour intensive. The labour demand for computer production is given by LC , whereas for shoes

it is LS . Similarly, capital demand for shoe production is KS and for computer production is KC .

(a) Draw a graph showing the relationship between the factor price ratio (put it on the vertical axis) and the relative demand for labour in the shoe production, , and in the computer production, . Draw the total relative supply in the same graph. [5]

(b) Show that, in equilibrium, the relative demand for labour is equal to a weighted average of the relative demands for the two industries,

LC + LS LC LS

KC + KS KC KS .

What are the weights α and β? Draw the relative demand for labour in the graph and ﬁnd the autarky (before trade) equilib- rium factor price ratio . [5]