International Trade Economics

Homework 1

Name

Purdue ID

Part 1. Questions that you do not need to turn in.

Answer the following questions. You do not need to turn them in.

Study Guide, Chapter 1, problems 1 ~ 5.

Study Guide, Chapter 2, problems 1,2, 4a,4b, 5 ~ 8. (Problem 1 includes 1a through 1i, etc.)

Part 2. Questions that you need to turn in. (56 points in total).

Question 1. (2 points each, 4 points total) Based on the iPhone example we used during the introduction classes (the slide titled “Trade in Intermediate Goods”).

Assume that the U.S. imports only 1 iPhone, and does not import anything else.

(1) According to the official trade statistics, how much (in dollar values) does the U.S. import from South Korea? Why?

(2) What is South Korea’s value added (in dollar values) in U.S. imports?

Question 2. (2 points each, 20 points total).

Consider the following Ricardian model.

MPL Labor Force

Apples Bananas

France 2 3 100

Italy 1 2 180

Please show your steps so that we can give you partial credits.

(1) Italy has the absolute advantage in bananas because its max banana output is 360, while the French max banana output is only 300. True or false? Why?

(2) Draw the PPF for Italy. Label the slope of the PPF and the max outputs of apples and bananas.

(3) Calculate the opportunity cost of apples (in terms of bananas) for France and Italy.

(4) What is the min and max value of Papples/Pbananas under the free-trade equilibrium?

For questions (5)-(10), assume that under the free trade equilibrium, PaT/PbT = 8/5.

(5) Show that Italy gains from trade using a graph with its PPF and CPF. You can draw this in the same picture as in question (2) above, or draw another picture.

(6) What is the terms-of-trade (TOT) for Italy?

(7) Calculate the real wage for apples in Italy under free trade.

(8) How does your answer in (7) compare with the real wage for apples in Italy under closed economy? What does this comparison mean?

(9) How does your answer to (7) relate to Italy’s TOT? What is the intuition of this relationship?

(10) Calculate the ratio of French wage with respect to Italian wage.

Question 3. Consider the following Ricardian model. Country U produces oil and cars using labor. The marginal products of labor for cars and oil are both constant. (12 points. 2 points each for (1)-(4), and 4 points for (5)). Please show your steps.

For questions (1) – (2) below, consider the closed-economy equilibrium for country U. Assume that the price of oil has decreased by 50%.

(1) What is the percentage change of the wages of oil-producing workers in country U, other things equal?

(2) What is the percentage change of the real wage in terms of oil in country U, other things equal?

For questions (3) – (4) below, consider the free-trade equilibrium for country U, in which country U exports cars. Assume that the price of oil has decreased by 50%.

(3) What is the percentage change of the wages of oil-producing workers in country U, other things equal?

(4) What is the percentage change of the real wage in terms of oil in country U, other things equal?

(5) Recently the world price has collapsed in the world market. Economist Joe’s job is to figure out the impact of this drop in oil prices on the U.S. economy. Which of the scenarios in (1)-(4) above is the most useful for Joe? Please explain your reasons. (4 points).

Question 4. Short Essay: While exports are good for the U.S. economy (e.g. raising demand for U.S. products and wages of American workers), imports are bad: they destroy American industries and American jobs and lower our standards of living. Comment. 20 points.

Hints: It is critical that you: 1. clearly state your main points; and 2. support your main points with theory (i.e. logic/reasoning, the models we have discussed in class, etc.).

Please finish your essay using MS word and print it out. 12 points, Times News Roman, double spacing. There is no min. requirement or cap for length. You are not expected to use data to support your arguments, but the use of data is a plus. If you choose to use data please list your data sources. (Hints: 1. Make sure the sources are credible before you use the data; 2. Examples with made-up numbers, like those we use in the Ricardian model, are theory, not data.)

Your essay will be graded based on substance (e.g. how well your theory (and data, if you use any) supports your arguments) and clarity of exposition.