Economics 355 (921) Midterm Examination complete solution correct answer key

University of British Columbia
Department of Economics
Economics 355 (921)
International Trade
Summer Session Term I, May 2012

Midterm Examination complete solution correct answer key

1. Consider a two-country, two-good Ricardian model. Explain what happens to wages
in each country and each industry going from autarky to free trade?

2. In a Ricardian world with two countries and three goods, where Home is more e¢cient
at producing all three goods, explain how it might be possible to have the Home country
export only one good and import only one good (a di§erent good).

3. Suppose that Cheese (C) andWine (W) are produced at Home with two inputs, Labour
(L) and Land (T). Marginal Productivities: MPLC, MPLW, MPTC and MPTW are all
constant. Use a diagram to show why the opportunity cost of producing Cheese may
not be constant.

4. Write out an equation to describe the Gravity model of Trade. What other factors
may influence the volume of trade between two countries? Is there empirical support
for the Gravity model? Provide an example.

PART B:
1. Consider the Specific Factors model of Trade. There are two goods, Manufactured (M)
products and Agricultural (A) products. Production of both goods requires labour (L)
and one additional input: Capital (K) for the production of the manufactured good
and Land (T) for the production of the Agricultural product. Labour is freely mobile
between both industries but the other factors are fixed and specific to an industry.
Labour displays diminishing marginal productivity in the production of all goods.
(a) In the Home country, autarky prices of the consumption goods are PAM
and PAA .
The Home country has labour supply, L. Use a graph to show how Labour is
allocated to each industry in autarky. Find the wages in each industry in autarky.

(b) What happens to the allocation of labour at Home if there a reduction to the
amount of Land in Home? What happens to wages in each industry? (Keep
goods prices fixed).

(c) Suppose that trade with Foreign raises the Price of the manufactured good at
Home, with no change to the price of the Agricultural good. Explain what will
happen to employment in each industry and wages. Explain what happens to the
Home country’s production of each good. Does trade lead to complete specialization
in this model?

(d) Consider the owners of each of the factors of production (workers, landowners and
capital owners), explain clearly how moving from autarky to free-trade a§ects the
real earnings of each of the factors of production in the Home country.

2. Consider a world with three goods, Cloth (C), Food (F) and Glass (G). There are 2
countries, Country X and Country Y. Labour is the only input used in production of
an output good.

(a) In autarky, both countries produce all three output goods. Find the autarky relative
prices of Cloth and Food (relative to Glass) in both countries

(b) If the free-trade wage ratio is wX
wY
= 5
2 describe the pattern of trade (which goods
will be exported by which country)

(c) Sketch a graph of the world labour market equilibrium, World Relative demand for
Country X labour relative to Country Y labour and Relative Supply of Country
X labour relative to Country Y. Your sketch should show values associated with
any horizontal portions of the Relative demand function and any values associated
with the Relative Supply function. Explain why the demand function has 

(d) Now suppose there is a third country, Country Z, with productivity

Determine where each good will be produced and describe the pattern of trade
(assume each country consumes all three goods).