Download 1) a) What is meant by producer efficiency

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Winter 2008, 160A Midterm1
Professor Farshid Mojaver
I. General Questions on International Trade Theory [24 points, 4 pts each]
1) Adam Smith argues that social interest is served best when individuals pursue their selfinterest “By pursuing his own interest he frequently promotes that of the society more
effectually than when he really intends to promote it”
a) What is meant by self-interest and social interest here?
Income/GDP
b) Under what conditions this might hold?
1- have competitive markets
2- self interest is followed within rules of the game
3- have good rules
2) How can international trade improve producer efficiency?
International trade allows countries to increase production because of better allocation of
resources. Better allocation of resources is the source of producer efficiency in IT.
3) How do you resolve this seemingly paradoxical result that the most productive domestic
firm may lose out to some of the least productive firms in a low wage country.
A local firm might be the most productive firm in a certain industry (say a US firm in apparel
industry) but the industry is not amongst the more productive industries in the country. That is the
productivity advantages of other firms are even higher than the firm in question (compared to
other countries). If the firm is located in a country that average productivity is high wages are also
high so the productivity advantage of the firm might not be strong enough to outweigh its wage
disadvantage.
4) How could the navigation act protect Britain domestic industry?
Giving monopoly of import to British ships leads to expansion of the shipping industry
which in turn strengthens British naval power. This was instrumental for furthering
British interest around the globe including opening and monopolizing new markets for
British products.
5) In a purely exchange economy with only two people and two goods show that trade is mutually
advantages to all partied. How is the result generalized to international trade between two
countries?
This mutual-gain conclusion can be generalized to international trade between two countries, as
long as countries are treated as a single unit (one nation like one person) and both countries are
engage in voluntarily trade. This result stems from countries having different endowments and
people having balanced and similar preferences.
6) In a purely exchange economy show that then there are more than two people involved trade is
not necessarily advantages to everyone. How is this generalized to international trade?
Trade is not advantages to everyone. Import competing industries lose out (are worse off
compared to autarky) and export industries gain in trade. This conclusion can also be generalized
to the context of international trade.
II-The Ricardian Model of Trade [32 points, 4 points each ]
Malaysia has 200 units of labor, while there are 400 units of labor in Indonesia. When they
produce, the countries have the following unit labor requirements.
ULR
Malaysia
Indonesia
Shirts
20
20
Cameras _
10
40
labor force
200
400
1) Which country has absolute advantage in shirt production and why? What about camera
production?
Malaysia has absolute advantage in Camera because it can produce Cameras
with fewer resources (labor) compared to Indonesia. No country has absolute
advantage in the production of shirts.
2) Which country has comparative advantage in Shirts and why?
OC of Shirts (in terms of Cameras) is 2 cameras in Malaysia and 0.5 cameras in
Indonesia. Indonesia has comparative advantage Shirt because opportunity cost of shirt
production is lower in that country.
3) What is relative price of Shirts in Malaysia before trade? What about Indonesia?
Relative price of Shirts before trade is equal to the opportunity cost of shirt production.
Autarky PS/PC in Malaysia = 2 and Autarky PS/PC in Indonesia = 0.5
4) Draw a graph showing production possibility frontier of Malaysia and Indonesia. Have
Shirt production of the horizontal axis and Camera on the Vertical axis.
QC
QC
Malaysia
LM /aLC =
200/10= 20
aLS/aLC = 2
10
10
QS
Indonesia
bLS/bLC = 0.5
LI /bLS = 400/20= 20
QS
5) If world price of shirts to cameras were 1 what would be the world production of Camera
and Shirts? Which country would produce each?
Indonesia produces 400/20 = 20 units of shirts and exports its excess supply.
Malaysia produces 200/10 = 20 and exports its excess supply.
6) Use a hypothetical indifference curve in a graph showing gains from trade for each
country (when international PS/PC =1).
QC
QC
Malaysia
20
Indonesia
PC/PS= 1
Cons’n
after trade
10
Cons’n
before trade
PC/PS= 1
10
QS
20
QS
7) Calculate relative wages for Malaysia to Indonesia after trade WM/WI
WM/WI = (bLS/aLC) PC/PS = MPLMal, C /MPLInd, S (PC/PS) = (20/10)*1 = 2
8) What will happen to the Malaysia-Indonesia wage gap if productivity of export sector in
Malaysia goes up? What happens to the wage gap when the productivity of import sector in
Malaysia goes up?
As MPLMal,C so does WM/WI . As MPLMal, S no change happens in WM/WI.
III. Questions in the Specific Factors Model
Consider a small open economy that produces Manufacturing and Food using labor,
capital. Labor is mobile, but capital is sector specific in the short run. KM denotes capital
employed in the manufacturing sector and KF capital in the food sector.
1. [9 points] Show the effect of an exogenous increase in the price Food (say because of
an increase in the world demand for food) on wages (both nominal and real), allocation of
labor, levels of production and rents on specific factors KM and KF (both nominal and
real).
2) [6 points] Suppose that under free trade Home would be exporting Food. Of the three
factors of production (L, KM and KF) which one would benefit from trade and which one
would lose out in the short run.
If Home exports Food that means relative price of food rises with trade. That would
increase return to the specific factor employed in the Food sector, RF and decrease that in
the Manufacturing sector RM. Owners of the factors specific to export sector would be
gain from trade and owners of factors specific to import sector would lose out.
IV. Factor Movement
1) [14 points] Show the effect of an increase in labor endowment on wages and rents in
the long run. (Hint: use an Edgeworth box and employ Small Open Economy assumption
to keep goods prices fixed)
As shown in the above figure, an increase in labor endowment (we suppose a reasonable
magnitude of increase) has no effect on the labor-capital ratio in either sector (computer
and shoe). Under standard assumptions, this implies that there is no change in the
marginal products of any factor in any sector. In addition, since home country is a small
open economy, prices are fixed. Thus neither wages nor rents respond to an increase in
total labor force in the long run.
2) [15 points] Using appropriate models and graphs show the validity of the following claims
a) there is a tendency for labor to migrate from the rest of the world to US
b) migration improves US GDP but it can lower the GDP of the ROW
c) migration is beneficial for the migrants and workers in the foreign country but it hurts
workers in the host country
d) owners of land/capital in the host country (U.S.) are better off as a result of labor
migration
e) the world as a whole is better as a result of migration
Wage
Wage
B
W
A
W’
C
W*
MPL
MPL*
O
L
L’
O*
Migration of labor from
Foreign to Home


•
There are two factors of production: Land (T) and Labor (L), two countries and one good.
Both countries have the same technology but different overall land-labor ratios. Home is
the land-abundant country and Foreign is the labor-abundant country.
Foreign workers would like to move to Home until the marginal product of labor is the
same in the two countries. Increase Home labor force & thus the real wage falls in Home.
Decrease the Foreign labor force & increase the real wage in Foreign.
The redistribution of the world’s labor force = >Increases the world’s output as a whole
 Leaves some groups worse off. Leads to a convergence of real wage rates

Assuming that the immigrant labor becomes the citizen of Home country
home national welfare in higher by ABLL’ while that of foreign country is
lower by ACLL’ and the net international gain is ABC,