Download Answer all five questions - the School of Economics and Finance

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NOT TO BE TAKEN AWAY
THE UNIVERSITY OF HONG KONG
School of Economics & Finance
2005-2006 2nd Semester Examination
Economics: ECON0301
Theory of International Trade
Dr S Chiu
Candidates may use any self-contained, silent, battery-operated and pocket-sized
calculator. The calculator should have numeral-display facilities only and should be
used only for the purposes of calculation. It is the candidate’s responsibility to ensure
that his calculator operates satisfactorily.
Candidates must record the name and type of their calculators on the front page of
their examination scripts.
Answer all five questions. They all carry the same points.
1. Assess whether each of the following statements is true, false or uncertain. In case
your answer is “false” or “uncertain,” please explain with less than 30 words.
a. Two countries with the same factor endowment and the same production
technologies will not benefit from trading with each other.
b. According to Rybczynski effect, an export biased growth will lead to
deterioration in terms of trade.
c. Suppose wool is the only input in the production of cloth, one unit of wool is
needed to produce one unit of cloth, and the free trade prices of a unit of wool
and a unit of cloth are Pw = $1 and Pc = $2. “Therefore, the effective rate of
protection on cloth is 50% for a small country that has a wool tariff of $0.5 per
unit and no tariff on cloth.”
2. Assume perfect competition in each market. Use the tool of PPFs, isovalue curves,
and indifference curves to illustrate that export subsidy is never welfare enhancing
for the country imposing it, regardless of the country size. Please label your
graph(s) clearly.
3. Use the Heckscher-Ohlin Model to examine how capital accumulation in one
country will affect the real rental price of capital in another. Specifically, use the
tools of the HO Model with two factors (labor and capital), two goods (laborintensive Food and capital-intensive Cloth), and two countries (Cloth-exporting
Home and Food-exporting Foreign) to do the following:
a. Show, for given prices, how an increase in the Home country’s capital stock
will affect its relative supply of Food.
b. Show how the change in relative supply of Food that you found in part (a) will
affect the equilibrium world relative price of Food.
c. Show how the change in world relative price of Food that you found in part (b)
will affect the real rental price of capital in the Foreign country.
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4. Consider a global economy of three countries characterized by bilateral trade
imbalances. Each country is endowed with a fixed quantity of a good which
consumers in the country and its “left-hand-side” (LHS) neighbor want to consume;
however, consumers in the “right-hand-side” (RHS) neighbor do not consume the
good at all, no matter how cheap it is. (See the figure below.)
Good 2
country 2
country 3
Good 1
Good 3
country 1
Country i’s trade policy, denoted by ti, is either free trade ( ti  0 ) and trade
protection ( ti  1 ), and we use ti , L to denote the country i’s LHS neighbor’s trade
policy. We assume country i’s welfare is
W  um (ti )  ux (ti ,L )
where um (ti ) =5 if ti  0 and 7 if ti  1 and u x (ti ,L ) =5 if ti ,L  0 and 2.5 if ti ,L  1 .
The three countries have a common discount factor, δ=0.9.
a. What is the one-shot Nash equilibrium of the game?
b. Now suppose the above game is repeated infinitely (so that the same quantity
of each good is replenished each period). Assume also that each country
observes its own trade policy as well as its LHS neighbor’s trade policy, but
not that of its RHS neighbor. Can global free trade be supported as an
equilibrium outcome? Explain.
c. To continue from (b), assume now that the three countries can form an
international organization to promote free trade: it will publicly announce it
whenever a country has violated free trade. Can global free trade be supported
as a (subgame perfect) equilibrium outcome? Explain. Will your answer be
changed if δ=0.5?
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5. The demand curve for computers in Hong Kong is: p = 50 – Q, where p and Q are
the price and the quantity demanded for computers in Hong Kong. Hong Kong
people satisfy their demand for computers by buying from the only local producer
as well as by importing from the rest of the world. The total cost of production of
the local producer is TC = 2q + q2, where q is its output level. The world price for
computer is $20.
a. Suppose there is free trade. Calculate the domestic price, the local firm’s
output level, and the amount of imports under free trade. Show your steps.
b. Suppose there is an import tariff, t, in place. Repeat part (a). In addition, what
is the amount of imports when t = $6/unit? Show your steps.
c. Suppose HK government adopts an import quota that restricts imports to the
amount that would prevail under an import tariff of t = $6. What will be the
resulting domestic production and domestic price? Show your steps.
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