Problem Set 1: Ricardo s Principle of Comparative Advantage
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1 ECO 6331: International Trade Fall 2018 Thomas Osang Due Thursday, September 13, 2018 Problem Set 1: Ricardo s Principle of Comparative Advantage Note: Always show your work, not just your final results. Handwritten answers are accepted only if they are neatly written!!! Part I: For each of the tables below, determine 1. the four autarky price ratios as well as the remaining free trade price ratio; 2. the pattern of trade, i.e., determine which country will export which good, based on Ricardo s principle of comparative advantage; 3. the gains from trade for producers in each country. Table 1: Country # of labor hours # of labor hours per yard of rayon per bushel of corn Home 13 8 Foreign 27 5 relative price of rayon with free trade: 5 2 Table 2: Country # of labor hours # of labor hours per yard of polyester per liter of beer Home 1/4 1/5 Foreign 1/2 1/5 relative price of polyester with free trade: 11 6
2 Table 3: Country # of labor hours # of labor hours per yard of linen per ton of wheat Home 8/5 5/3 Foreign 6/5 4/3 relative price of linen with free trade: 33 35
3 Write your answers in the corresponding tables below: Table 1: Answers ( P R PC P R P R gains from trade Table 2: Answers ( P P P B ( P B PP ( P B PP gains from trade Table 3: Answers ( P L P W ( P W PL ( P W PL gains from trade
4 Part II: Consider two countries (hereafter called the home and the foreign country) whose representative consumers have the following preferences, as represented by the utility they receive from consuming food and clothing: U(C C, C F ) = C 2 CC 3 F ; U (C C, C F ) = C 3 C C4 F. In each country, the available technology allows production of two goods, food and clothing. The home country needs two units of labor to produce a unit of clothing and three units to produce a unit of food. The foreign country needs five units of labor to produce a unit of clothing and two labor units to produce a unit of food. The home country is endowed with 120 units of labor, while the foreign country is endowed with 160 units of labor. 1. Using Ricardo s principle of comparative advantage, explain briefly why both countries have an incentive to engage in trade and which country will export which good? 2. Determine the equation for the production possibilities frontier for each country. What is the marginal rate of transformation in each country? What is the autarky price ratio between clothing and food in each country? 3. Calculate the quantity produced and consumed in autarky for each of the two countries. 4. Draw the PPF and the autarky equilibrium for each country, placing clothing on the horizontal and food on the vertical axis (It may be helpful to use graph paper for the diagrams). 5. If we assume perfect competition, what will the autarky real wage rate, (w/p F, be in the home country? What will the real wage rate, (w /p F, be in the foreign country? 6. Calculate how many units of labor are being used in the clothing and how many in the food industry in autarky in each country. 7. Assuming that free trade leads to complete specialization in production, calculate free trade production of clothing and food in each country. 8. Calculate the free trade equilibrium price ratio between clothing and food as well as free trade consumption of clothing and food for both countries.
5 9. For each country, calculate exports and imports. 10. Draw the free trade equilibrium in the corresponding diagram from question 4. Also, show the trade triangle for both countries. 11. What will the free trade real wage rate, (w/p F, be in the home country? What will the real wage rate, (w /p F, be in the foreign country? 12. Show that consumers in both countries have benefited from trade by calculating autarky and free trade utility for each country. Write your answers for the autarky and free trade equilibria in the corresponding tables below.
6 Table 4: Autarky Equilibrium Q A C = CC A Q A F = CF A ( w C ( w F L A C L A F Table 5: Free Trade Equilibrium Q T C Q T F C T C C T F X T C X T F M T C M T F ( w C ( w F utility in autarky (in million) utility in trade (in million)
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