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Name _________________________

Due Date: April 22nd

This exam consists of two parts. The points add up to 60 points total.

PART I. TRUE/FALSE (#1-6) AND MULTIPLE CHOICE (#7-9)

• 3 points each x 8 questions = 24 points total • You must answer 8 out of these 9 questions.

o Leave one question blank or mark clearly the one you wish to omit! o If you answer all nine questions, I will grade only the first eight!

• Please write all of your answers in the space provided.

PART II. PROBLEMS AND GRAPHICAL ANALYSIS

1. Two-good Ricardian Model. (9 points) 2. Heckscher-Ohlin Model. (9 points) 3. Monopolistic Competition and Intra-Industry Trade. (9 points) 4. Welfare Analysis of a Subsidy. (9 points)

• Part II is worth: 36 points total. • You must answer ALL the problems. • Please show all of your work in the space provided.

GOOD LUCK!

ECO 441 Prof. Miguel A. Iraola

December, 2014

Problem Set 4: Sample Final Exam

1. TRUE / FALSE

Mexico and the US both produce tomatoes and corn. Suppose that due to differences in technology, both tomato producers and corn producers are twice as productive in the U.S. as they are in Mexico. Under this assumption, the Ricardian Model predicts that there are no gains from US-Mexican trade in tomatoes and corn.

Explanation:

2. TRUE / FALSE

Ashenfelter and Jurajda (2001) calculated the “McWage”—i.e. the real wage defined in terms of Big Mac consumption possibilities—for 27 countries in 2000, and found that the McWage in Canada (2.4 Big Macs) was four times larger than the McWage in Argentina (0.6 Big Macs). This evidence lends greater support to the Hecksher-Ohlin Model than to the Ricardian Model.

Explanation:

3. TRUE / FALSE

Consider a free trade equilibrium in the Heckscher-Ohlin model with two factors of production, capital (K) and labor (L), and two goods. Then, import-biased growth in the relatively labor- abundant economy reduces the relative price of the labor-intensive good.

Explanation:

4. TRUE / FALSE

The existence of External Economies of Scale in an industry implies that temporary protection of this industry may improve world welfare.

Explanation:

5. TRUE / FALSE

An export subsidy results in an increase in domestic aggregate welfare as long as the importing country’s market is large enough that the subsidy induces a decline in the world price of the good.

Explanation:

6. TRUE / FALSE

The model of intra-industry trade based on internal economies of scale and monopolistic competition implies that in the integrated market equilibrium there are more companies operating at a greater scale.

Explanation:

PART I, CONT’D. MULTIPLE CHOICE.

Circle the letter(s) corresponding to the correct answer(s)

• Put an X through the answer(s) that are incorrect. • Note: In each case, there is at least one correct answer. There may be more than one

correct answer. • No explanations are required.

7. The model of intra-industry trade based on internal economies of scale and monopolistic

competition predicts that in a free trade equilibrium:

a. The best performing firms expand and the worst performing contract or exit.

b. Trade an economic integration improve industry performance.

c. Trade reduces the operating profit of the firms with lower marginal cost.

8. Suppose that capital owners in country A employ labor to produce good X, some of which is exported to country B. Which of the following would increase the incentive of capital owners in country A to locate some of their production facilities in country B:

a. An increase in country B’s demand for good X.

b. A reduction of country B’s tariff rate on good X.

c. A reduction of fixed costs (smaller economies of scale) in the production of good X.

9. Two countries, Home and Foreign, produce output using land and labor. The diagram below shows how the marginal product of labor varies with total employment in these countries. (Home’s origin is at the bottom left corner and Foreign’s is at the bottom right.) Home country workers initially earn a real wage of 70.

100

110

0 10 20 30 40 50 60 70 80 90 100

LForeign

Which of the following results is/are consistent with the model’s predictions regarding the effect of free labor mobility between the two countries?

a. 20 workers migrate from Foreign to Home.

b. Home’s wage rises by 60.

c. Home’s output increases by exactly the

same amount as Foreign’s output falls.

MPLHome

MPLForeign

LHome

PART II. Solved Problems & Graphical Analysis 1. Two-good Ricardian Model (9 points) Assume that the unit labor requirements (labor-hours per unit of each good) for Computer Chips (CC) and Shirts (S) production in the US and the Mexico (MX) are: and the countries’ labor supplies are: LUS = 200 and LMX = 10,000. (a) Fill in the table above the opportunity cost of CC (in terms of S) in the US and MX.

(b) Which country has a comparative advantage in CC production? ____________________ (c) Which country has an absolute advantage in CC production? ____________________ (d) Sketch the world relative supply curve describing the amount of CC produced relative to the amount of S as a function of PCC/PS. Clearly label and explain the intercepts and points at which the RS curve is bent or ‘kinked’.

0.1

0.2

0.3

0.4

0.5

0.6

0 0.1 0.2 0.3 0.4 0.5

CC S Opp. Cost

𝑄!! 𝑄!

𝑹𝑫: 𝑄!! 𝑄!

= 1 2 − 𝑃!! 𝑃!

𝑃!! 𝑃!

(d) The world relative demand curve shown in the graph corresponds to the relative demand function: QCC/QS = 1/2 – (PCC/PS). What is the relative price of cloth in the free trade equilibrium? (PCC/PS)world = _________

(e) Construct the consumption possibilities frontier for each country, under autarky and with free trade. Label all endpoints clearly.

(f) Do both countries gain from trade? Explain briefly, using the diagrams as a reference. (g) Assuming that the wage rate in the U.S. is wUS = 5 $/hr, compute the Mexican wage rate (wMX) in the free trade equilibrium.

QCC

Relative Quantity of Cloth (QC/ QA)

Relative price of Cloth (PC/ PA)

RD US =RD

Mexico

2. The Heckscher-Ohlin Model (9 points) Suppose that the US and Mexico (MX) both produce two categories of goods–cloth (C) and aircrafts (A)–using labor (L) and capital (K). Cloth production is relatively labor-intensive, while aircraft production is capital-intensive. Mexican capital stock per worker is substantially lower that the capital stock per worker in the U.S. Assume that tastes and technologies are identical in the two countries.

(a) On the graph below, sketch & label the relative supply curves of the two countries and the world relative supply curve.

(b) Suppose that the US and Mexico trade freely. Which good will Mexico export to the US?

• The relative price of cloth (PC/ PA) in the U.S.: increases/decreases

• The real wage in the U.S.: increases/decreases Briefly explain why:

• The real wage in Mexico: increases/decreases Briefly explain why:

(d) Of the four groups below, who are the “winners” and who are the “losers” from the freeing of trade between the U.S. and Mexico?

• Capital owners in the U.S.: winners/losers

• Capital owners in Mexico: winners/losers

• Workers in the U.S.: winners/losers

• Workers in Mexico: winners/losers

(e) What is the effect of an increase in the stock of capital in the US on:

• The relative price (PC/ PA): increases/decreases • The real wage in Mexico? increases/decreases • 𝐾!/𝐿! !": increases/decreases

3. Monopolistic Competition and Intra-Industry Trade (9 points) Suppose that the market for motorcycles is characterized by monopolistic competition, and that there are four identical countries in the world that produce motorcycles. Take the following assumptions as given:

• The initial size of each country’s market is Si = 4,000,000 (motorcycles sold). • All firms in each country have identical cost structures and symmetric demand curves, so

that they set the same price and share the market equally. Hence each firm sells 4,000,000/ni, where ni represents the number of firms in country i.

• The fixed costs of production for a firm in the motorcycle industry are F = $100,000,000 and the variable cost per finished motorcycle (= constant marginal cost) is equal to c = $1,000.

• Under autarky, the market price in each country is given by: Pi = c + 100/ni. a. Calculate the equilibrium number of firms (ni) in each country’s market without trade. Show

your work and circle your final answer.

b. Calculate the autarky equilibrium price of a motorcycle. c. Now suppose that the four countries form a free trade agreement for motorcycles, so that

their markets are completely integrated. Calculate the equilibrium number of firms in the integrated world market (nworld).

d. Calculate the free trade equilibrium price of a motorcycle and the average production cost.

e. Compare the aggregate number of firms operating in the equilibrium without trade with the number of firms operating in the integrated market equilibrium. Are there more companies operating in the integrated market equilibrium?

g. Compare firm production levels with and without trade.

4. Welfare effects of a Subsidy (9 points)

Suppose the domestic demand and supply of smartphones in a SMALL open economy are given by:

QD = 50 – P; QS = -30 + 3P

The domestic supply and demand curves are shown in the diagram below.

(a) What is the equilibrium price and quantity in autarky?

(b) Suppose the world price is equal to $25 per handbag. What are the free trade levels of :

• domestic consumption? _________

• domestic production?_________

• exports? ______________

(b) Suppose now that the country pays a subsidy of $10 on handbag exports.

Using the graph below, identify the effects of this subsidy on the following. When calculating changes in surplus, be sure to indicate whether the change is positive (gain) or negative (loss).

• the new domestic price of handbags: ___________

• the new domestic production of handbags: ________

• total change in producer surplus: ____________

• new domestic consumption: ____________

• total change in consumer surplus: ____________

• government expenditure on the subsidy: ___________

• net change in country’s total welfare: ________

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