Econ 178-001 International Trade Problem Set 3 Spring 2018

Econ 178-001 International Trade Problem Set 3 Spring 2018

Please answer the following questions on separate sheets of paper. One of the questions will be randomly graded. The rest of the assignment will be “graded” for completeness. See syllabus for more details.

1. The specific-factors model is often referred to as the short-run model. Why is this the case and how does it relate to the marginal product of labor (MPL) in each sector and the production possibilities frontier (PPF)?

2. Assume that there are only 100 workers in the economy (i.e. LA + LB = 100). The marginal product of labor curves corresponding to the production functions in problem 2 are as follows

Workers Employed MPL in Sector A MPL in Sector B 10 1.51 1.59 20 1.14 1.05 30 1.00 0.82 40 0.87 0.69 50 0.78 0.60 60 0.74 0.54 70 0.69 0.50 80 0.66 0.46 90 0.63 0.43

100 0.60 0.40

a. Suppose the price of good A is $10 and the price of good B is $20. Determine the equilibrium nominal wage and labor distribution in this economy.

b. Sketch a graph of the labor market and mark the equilibrium wage and labor distribution.

c. Suppose the price of good B decreases to $13. Determine the new equilibrium wage rate and labor distribution. Illustrate this effect on the graph you drew in part (b).

d. Calculate the real wage in terms of good A and good B before and after the price change. Are workers better or worse off because of it?

3. A country’s labor market between food (QF) and clothing (QC) is currently in equilibrium. Labor is used to produce both goods. Land (T) is only used to produce food and Capital (K) is only used to produce clothing.

a. Draw a graph that shows the equilibrium wage. Put the origin for the clothing axis on the left side of the graph. Be sure to clearly label your axes and indicate the equations that represent each curve.

b. Explain why the equilibrium wage occurs when wages in both industries are equal.

c. Assume that the price of food falls and the price of clothing remains the same. Show the effect on the graph that you drew in part (a). Would this suggest the country is importing or exporting food?

d. Explain what happens to the real wage in terms of clothing. Show and explain what happens to the real wage in terms of food. Are workers are better off?

e. Building off part (c), show and explain what happens to the real returns to capital and land when the price of food falls and the price of clothing remains the same.

2

4. Assume that labor moves into the agricultural sector and away from the manufacturing sector. This will cause the marginal product of land (MPTA) to increase and the marginal product of capital (MPKM) to decrease.

a. Does this contradict the assumption we usually make about diminishing marginal product? Explain.

b. Briefly explain the real-life intuition as to why this occurs.

5. Consider a specific-factors model of two goods, clothing (QC) and food (QF)

a. Draw a PPF for the Home country in Autarky with QC on the x-axis and QF on the y-axis of your graph. Next label the production and consumption point of QC=50 and QF=50 as A and draw the indifference curve (labeled U1) that is associated with it.

b. Assume that Home has a comparative advantage in food and decides to trade with Foreign, show on the graph a new world price and how this will alter the production point (labeled B), consumption point (labeled C) and utility (labeled U2). You do not need to provide numerical values for any of the points, but the relationships between points should be clear.

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