6 Eco problems - need urgently

Department of Economics University of California, Berkeley

Spring 2014 Economics 181

PROBLEM SET 4

Due on Thursday, May 1 beginning of lecture. Please, write your full name, GSI, and section

number on your problem set.

Note: Please, pay attention to the organization of your answers. Always keep the order of

the questions, write legibly, and clearly indicate what you are doing. Please staple your answer

sheets together.

After derivations that need several steps, always mark your final answer clearly: put a box

around it, underline it or highlight it.

Question1 Ricardo

Consider two countries Turkey and Greece with the following unit labor requirements for two

products they produce, automobiles and home appliances.

ULR(a) Automobiles(A) Home Appliances(H)

Turkey 3 2

1

Greece 2 6

Suppose the labor endowments for Turkey and Greece are 80 and 12 respectively. Also

suppose the countries have identical C-D preferences given by U(H, A) = H↵A1�↵ .

(1) For what values of ↵ the free trade equilibrium is one where countries are completely

specialized in their comparative advantage sector?

(2) Take price of autos as the numeraire, that is pA ⌘1. Suppose the relative world price p⇤

H

p⇤ A is 2. What is the wage in Turkey and Greece?

(3) Now focus only on Turkey and assume the world price is determined in the rest of the

world which is p⇤

H

p⇤ A

= 2. Suppose initially that Turkey is under autarky and labor is

immobile. Find the real wages in sector H and A in terms of both goods before and

after the country opens to trade. Who gains and who loses? 1

Department of Economics University of California, Berkeley

Spring 2014 Economics 181

Question 2 Heckscher-Ohlin

Suppose that (1) the United States (US) and China are two countries producing and con-

suming cloth and microchips. Suppose further that (2) cloth production is labor intensive and

China is labor abundant, and (3) microchips production is capital intensive and the US is

capital abundant.

(1) Use a Heckscher-Ohlin (H-O) model diagram like below to clearly and accurately show

US’s and China’s autarkic (1) relative price of microchips over cloth, (2) relative factor

price R/w, and (3) the relative factor proportions in both the cloth and microchips

industries. (Draw them on the same graph.)

PS 4

Suppose that (1) the United States (US) and China are two countries producing and consuming

cloth and microchips. Suppose further that (2) cloth production is labor intensive and China

is labor abundant, and (3) microchips production is capital intensive and the US is capital

abundant.

(a) Use one Heckscher-Ohlin (H-O) model diagram below to clearly and accurately show US’s

and China’s autarkic (1) relative price of microchips over cloth, (2) relative factor price

R/w, and (3) the relative factor proportions in both the cloth and microchips industries.

(Draw them on the same graph.)

� �

� R w

K L

Pm Pc

(b) Suppose that China and the U.S. start to engage in trade. On the same diagram as in (a)

and using a di�erent color pen or pencil than used before show US’s and China’s new (1)

relative price of microchips over cloth, (2) relative factor price R/w, and (3) the relative

factor proportions in both the cloth and microchips industries.

(c) Provide a brief economic explanation of the results you have shown in your diagrams for

parts (a) & (b). Which theorem in the Heckscher-Ohlin framework predicts the result?

1

(2) Suppose that China and the U.S. now engage in trade. On the same diagram as in part

1 and using a di↵erent color pen or pencil than before show US’s and China’s new (1)

relative price of microchips over cloth, (2) relative factor price R/w, and (3) the relative

factor proportions in both the cloth and microchips industries.

(3) Provide a brief economic explanation of the results you have shown in your diagrams

for parts 1 & 2. Which theorem in the Heckscher-Ohlin framework predicts the result?

(4) Imagine that due the the strict birth control policy, labor force in China declines over

time (but suppose that China is still relatively labor abundant compared to US). How

does this change a↵ect (1) US TOT; (2) China’s TOT; (3) US overall welfare; (4) 2

Department of Economics University of California, Berkeley

Spring 2014 Economics 181

China’s overall welfare; (5) relative factor price R/w? Hint: Apply the analysis in

the Standard Trade Model.

(5) Imagine that there is a major breakthrough in microchip production technology. Show

its e↵ect on (1) US TOT; (2) China’s TOT; (3) US overall welfare; (4) China’s overall

welfare; (5) relative factor price R/w. Hint: The technological progress a↵ects

production in both US and China.

(6) Given your findings in part 5, why does the US government still encourage innovation

in the microchip industry in the real world?

Question 3 Trade Wars and Trade Agreements

Consider two large countries, the US and Japan. Suppose each country can unilaterally

impose an optimal tari↵ or choose no protection.

(1) Provide an economic rationale for this payo↵ matrix.

(a) Find the pure strategy Nash equilibrium of the above matrix.

(b) What is the problem with this equilibrium outcome?

(c) As an advisor for Japan, what suggestions would you o↵er the country’s trade

o�cials when it comes to solving the issue identified in part c?

(2) Now consider 2 small countries, Guatemala and Palau. As in the first section, each

country can unilaterally impose a tari↵ or choose no protection.

(a) Provide an economic rationale for this payo↵ matrix (your discussion should refer-

ence how this payo↵ matrix di↵ers relative to the large country case).

(b) Find the pure strategy Nash equilibrium of the above matrix. 3

Department of Economics University of California, Berkeley

Spring 2014 Economics 181

(c) We often see small countries impose tari↵s, what arguments from Chapters 10 and

11 might a small developing country use to validate such actions?

(3) Now suppose we have one large country and one small country, with the following payo↵

matrix.

(a) Provide an economic rationale for this payo↵ matrix (your discussion should refer-

ence how this payo↵ matrix di↵ers relative to the other two cases).

(b) Find the pure strategy Nash equilibrium of the above matrix.

(c) What actions could Palau take in response to US actions under the Nash equilib-

rium outcome (reference the discussion of Administrative Reforms in Chapter 10

suggest)?

(d) What does the above analysis imply for the prospects of the Doha Development

Round (be brief, maximum 3 sentences)?

Question 4 Strategic Trade Policy

(1) There are two competing firms, Boeing in the US and Airbus in France. Both can

produce super jumbo jets.

(a) Find all pure strategy Nash equilibria.

(b) What does this outcome imply for the pattern of production across countries? Who

will produce in equilibrium?

(2) Suppose the US government decides to provide Boeing with a production subsidy of

100.

(a) Write down the resulting payo↵ matrix. 4

Department of Economics University of California, Berkeley

Spring 2014 Economics 181

(b) Find all new pure strategy Nash equilibria.

(c) What does this outcome imply for the pattern of production across countries? Who

will produce in equilibrium?

(d) Suppose Airbus can enter the market first, how does this change your answer to

part c?

(e) What hesitations do you have about the US government’s ability to influence the

equilibrium outcomes? Reference Chapter 12, but be concise.

Question 5 Policy

It is 2004 and Costa Rica is about to form a PTA (preferential trade agreement) with the

US. The cost of rice in the US is $10, while it is $8 in Thailand and $12 in Costa Rica.

(1) If the tari↵ in Costa Rica is $3, what is the impact of the PTA for Costa Rica? Is there

trade creation or trade diversion? What is the impact on the price for consumers and

the country as a whole?

(2) Redo part 1 but starting with a tari↵ of $10.

Question 6 Marshallian Externalities

Consider a small open economy with a labor force of 1000 in a world where there are two

goods: co↵ee and medical devices. The unit labor requirement (ULR) in co↵ee is 2 whereas the

ULR in medical devices (MDs) is decreasing because of Marshallian Externalities. In particular,

the ULR in MDs is 10 if employment is zero, whereas it falls to 4 when the industry reaches

employment above 100. Imagine that the international relative price of MDs in terms of co↵ee

is 3.

(1) Are there multiple equilibria?

(2) Compute the wage in the two equilibrium. Which one is higher?

(3) If the equilibrium is the one with specialization in co↵ee, does the country gain or lose

from trade? Draw the appropriate figure to illustrate your answer. In answering this

question, assume that employment in MDs in autarky is above 100.

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