Download Mids-SS106 - UC Davis economics

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SSI 2006, 160A Midterm
Professor Farshid Mojaver
I. General Questions on International Trade Theory (40pts)
1) [6 pts] How can international trade improve consumer and 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.
In addition, international trade allows consumers to have a more stratifying
collection of consumer goods and services. This is the source of consumer
efficiency.
Thus with IT consumers are better off not only because they can consume more
(because of higher production resulting from higher production efficiency) but
also because they can have a better collection of goods (higher consumer
efficiency).
2) [4 pts] How can a developed country compete against some low foreign wage
industries?

Wage rates reflect overall productivity levels. Higher wages in DCs imply higher
productivity in those countries. However the productivity advantages over low wage
countries are not the same in every sector. In some sectors it is larger than wage
differentials and in some smaller. If the DC specializes on the sectors in which its
productivity advantages are larger than its wage disadvantages then it can easily
compete with low wage countries.
3) [12 pts] False, True, Or Uncertain, Explain Why (in plain English) [3 points each]
a) Voluntary exchange is beneficial to everyone in both individual and national levels.
False.
b) The HO theory can successfully explain patterns of trade between all countries and in
all goods.
False. HO predictions are most useful for analyzing North-South trade and
trade in resource intensive products. But that constitutes only a small fraction of
all international trade.
c) A domestic firm may lose out in international competition even if it is the lowest cost
producer in the world
True
d) “Opening up free trade does hurt people in import-competing industries in the short
run. But in the long run, when people and resources can move between industries,
everybody ends up gaining from free trade.”
False
4) [6 pts] Consider the following information regarding international trade between India
and US. Of the two models that you have learned in class so far (Ricardian and H-O) which
model (if any) describe India-U.S. trade patterns best?
India’s top exports to U.S.:
1. Non-metalic minerals/gems
2. Clothing
3. Textiles
4. Jewelry
5. Metal manufactures
India’s top imports from U.S.: 1. Aircraft
2. Office machines and computers
3. Industrial machinery
4. Power generation equipment and engines
5. Scientific equipment
India’s top 5 exports to US are all labor intensive products. This fits well with HO model
since India can be characterized as a labor abundant country and US as a labor scare
country.
However the Ricardian model could also be invoked to explain the observed trade
pattern too. It could be that relative to other sectors India is more productive in these
sectors compared to US (its productivity disadvantages are lower in these sectors) and
hence it enjoys a labor cost advantage.
India’s top 5 imports from US are all capital and skilled labor intensive. This fits well the
HO model. However these imports could also be characterized as high tech products.
Then once again the Ricardian model could be used to explain US comparative advantage
in those sectors.
5) [12 pts] Gravity and Boarder
a) Write the equation for the Gravity model and briefly explain what it says.
Tij = A x Yi x Yj /Dij
Where Tij is the value of trade between country i and country j, A is a constant
Yi and Yj are the GDP of country i and j and Dij is the distance between the
country i and country j
The gravity model predicts that volume of trade between two countries increase in
with the size of their GDP and falls with the distance between their markets.
b) How well are the predictions of the Gravity model? Does it predict well for all
countries?
Gravity equation performs extremely well empirically for the industrialized
countries (and not well at all for non-OECD countries)
c) The cross-provincial trade in Canada was some 22 times larger that cross-border
trade in 1988. What can explain this?
Crossing borders involves formalities that take time and perhaps monetary costs
like tariffs. These implicit and explicit costs reduce trade. The existence of
borders may also indicate the existence of different languages or different
currencies, either of which may impede trade more.
II-The Ricardian Model of Trade [24 points, parts 3 pts each]
The United States has 200 units of labor, while there are 1600 units of labor in India. When
they produce, they have the following unit labor requirements.
ULR (hr/unit of output)
Clothing
Machines
U.S.
2
1
India
10
20
1) Which country has absolute advantage in the production of clothing and why? What about
machines?
U.S has absolute advantage in both machines and clothing because her labor
productivity in both sectors are larger than those of India.
2) In absence of trade, what is the opportunity cost of clothing (in terms of machines) in the
India and the U.S.?
OC of Clothing (in terms of machines)
U.S
aLC/aLM
2/1 = 2
India
bLC/bLM
10/20 = 0.5
3) For which product does India have comparative advantage?
India has Comparative Advantage in Clothing production because her
opportunity cost of clothing is lower than that in United States
4) What is the relative price of clothing in each country before trade?
Autarky PC/PM in U.S = 2
Autarky PC/PM in India = 0.5
5) Draw a graph showing production possibility frontier of U.S. and India. Have Clothing
production of the horizontal axis and machines on the Vertical axis.
QM
QM
Unites States
LM /aLC =
200/1= 200
India
bLC/bLM = 0.5
aLC/aLM = 2
80
QC
100
LI /bLC = 1600/10= 160
QC
6) If world price of shirts to Machines were 1 what would be the world production of
Machines and Clothing? Which country would produce each?
India produces 160/20 = 80 units of Clothing and exports its excess supply.
U.S. produces 200/1 = 200 and exports its excess supply.
7) Use a hypothetical indifference curve in a graph showing gains from trade for each
country (when international PC/PM =1).
QM
QM
Unites States
India
200
Cons’n
after trade
Cons’n
before trade
80
PC/PM = 1
PC/PM= 1
100
QC
8) Calculate relative wages for United States to India after trade WUS/WInd =
WUS/WInd = (bLC/aLM) PM/PC = 10/1 = 10
160
QC
III- Hecksche-Ohlin Theory, Increasing Wage Gap and Outsourcing
Use the Feenstra model to explain the following questions: [11 points]
1) [6 pts]Explain the effects of US outsourcing to China on US and China’s welfare
Suppose there are three factors inputs (unskilled labor, skilled labor, and capital) used to
produce two intermediate goods y1 and y2; where y1 is an unskilled-labor intensive (such
as activities done in a factory) and y2 is a skilled-labor-intensive non-production input
(such as R&D, marketing and after-sale services). The two intermediate goods (y1 and y2)
are bundled together to produce a final food yn (labor or capital is not used in bundling).
All three products can be internationally traded.
Suppose U.S. is skilled-labor abundant.
Then according to H-O model = => we expect that U.S. to
– export y2 (skilled-labor-intensive intermediate input) and
– import y1 (unskilled labor-intensive intermediate input).
And just as of H-O model we expect welfare of both countries to improve as a result of
this trade (more of the two intermediate goods and the final good will be produced
because of better international allocation of resources).
2) [5 pts] Explain the effects of US outsourcing to China on the unskilled- skilled wage
gap in the two countries
International trade will result in a price reduction of the unskilled-intensive intermediate
product y1 in U.S. The effect of this is like that of Stolper-Samuelson, that is:
Py1↓ (unskilled labor-intensive) = =>↓wU/wS
In China we have the opposite that is Py2↓ (skilled labor-intensive) = =>↑wU/wS
III-Factor Movement and Income Distribution [25 pts, Impact 8, SR 12 and LR 5 points]
What are the effects of illegal labor immigration on US economy? In answering this
question consider two sectors in the economy: Agriculture and Manufacturing. Assume
that the illegal immigrants are initially employed in the Agriculture but in the Medium
run they can move to the Manufacturing.
Use the proper models you have seen in the class and make the proper assumption to
analyze the effect of such immigration on US outputs, and real factor prices. Carry your
analysis in three scenario: (i) Immediate or Impact, (ii) Short-Medium Run and (iii)
Long-Run effect.
(i) Impact analysis
In the very short run all factors of production are sector specific
QM = Q(KM,LM) and QA = Q(KA,LA)
With an increase in the type of labor that can be employed in the Agricultural sector
employment in that sector goes up. This leads to an increase in production in Agriculture.
Increase in the employment of labor in agriculture bid wage rates down in that sector. So
far there is no change in Manufacturing, either in employment, production, wages or
rents. In the very short run labor can not move between the two sectors.
An increase in employment in Agriculture implies an increase in MPT which leads to an
increase in Land rentals. Since goods prices have not changes all the factor price changes
in this model are real.
WA=WM
W’A
PAMPLA
QM
PAMPL’A
PMMPLM
L1
QA
∆L
(ii) Short-to Medium Run analysis
In the medium run capital employed in each sector can be considered sector specific and
labor mobile between the two sectors
W”A=W”M
PAMPLA
QM
PAMPL’A
L1
PMMPLM
L2
∆L
QA
Wages in both sectors are lower compared to the situation before immigration.
Increase in employment in the manufacturing leads to an increase manufacturing
production and an in MPK. With goods prices fixed the latter implies an increase in rents
on capital. The rents on land is also higher compared to the situation before trade.
Return on K
SK
R’K
RK
MPK(L’M)xPM
MPK(LM)xPM
K
(iii) In the Long Run
According to the Rybczynski Theorem in a small open economy an increase labor
endowment leads to an increase the production of labor intensive product and a reduction
in the capital intensive. But factor prices remain the same (because of fixed international
goods prices).