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UK ECO 471 - Exam

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Summarize your answers here.ECO 471 NAME _______________________ Fall 2005 EXAM 1 ID _______________________ a. You may use back pages if necessary. b. Total is 100 points. Part I (20 points) Consider a 2×2 Heckscher-Ohlin model with the following setting. • Two countries A and B produce wine and cheese. Country A is endowed with 400 units of labor (man-hours) and 600 units of land (acres). Country B’s endowments are 500 units of labor and 1000 units of land. • At the current wages and rentals, producing a gallon of wine requires 10 units of labor and 5 units of land. A pound of cheese requires 4 units of labor and 8 units of land. For each of the following statements, choose whether it is True or False. And then explain briefly. 1. Country B is abundant in both labor and land. 2. Wine is labor-intensive. 3. Country B has comparative advantage in wine. 4. In country B, the relative price of wine declines with trade. 5. In country B, the wage/rental ratio rises with trade. 6. In country B, workers are likely to be opposed to trade.Part II (40 points) Unit labor requirements for two goods butter (B) and cheese (C) for two countries are given below: France Germany Butter 10 5 Cheese 4 3 Labor Supply 8000 6000 1. Fill in blanks and summarize your answer in the underlined space below. No explanations are necessary. Under autarky, the relative price of butter to cheese is ( a ) in France. Germany has comparative advantage in ( b ). If the German hourly wage rate is $30, the French wage rate cannot be higher than ( c ). a. __________________ b. ____________________ c. _____________________ 2. Suppose that according to a report, 400 units of butter are traded for 800 units of cheese each period. In the following diagram for France, show and mark (i) “PPF” for the production possibility frontier, (ii) “CPF” for the consumption possibilities frontier, (iii) “P” for the production point in trade, and (iv) “C” for the consumption point. Use the X-axis for butter as indicated. Cheese Butter 3. At the terms of trade mentioned in (2), if the German hourly wage rate is $30, the French wage rate should be ______. Show your work. 4. Is trade illustrated above beneficial for France? Compare the cost of production of butter in direct production and indirect production.Part III (20 points) The market demand and supply curves for widgets in a small country called Wizzo are shown below. The world price of the widget is $6 under free trade. P($) 28 Domestic Supply 16 12 World Price +Tariff 6 World Price 4 Domestic Demand 10 40 60 80 110 Widgets a. In the Figure above, in the absence of trade how many Widgets does this country consume? b. If the country is able to trade at $6 with no tariff, what is the country's consumer surplus? c. With a specific tariff of $6 per unit, what is the quantity of Widget imports? d. The loss of consumer surplus due to the tariff equals _____. e. The producers’ gain from the tariff equals _____. f. Does Wizzo gain or lose from the tariff? How much? Use a negative sign if it loses. g. If Wizzo were a large country in the identical setting as the above, will the same tariff have the same effects as above? Discuss the qualitative differences, if any, in the effects on (i) the after-tariff domestic price, (ii) the reduction in imports, and (iii) net gain or loss in national welfare. Summarize your answers here. a. __________ b. __________ c. __________ d. __________ e. __________ f. __________ g.Part IV (20 points) 1. Mexico and Brazil have very different trading patterns. (a) Mexico trade mainly with the United States, Brazil trade about equally with the United States and with the European Union; (b) Mexico do much more trade relative to its GDP. Explain these two differences using the gravity model. 2. “Foreign competition is unfair when it is based on low wages. It hurts us in a high-wage country.” Comment on the statement. Discuss among other things, why those foreign countries have low wages and whether trade with low-wage countries hurt us indeed.Answers Part I. First, find that Country B (A) is abundant in land (labor) and that cheese (wine) in land (labor) intensive. 1. False. A country cannot be abundant in both factors. The T/L ratio = 600/400 in A and 1000/500 in B. Thus, B is abundant in land. 2. True. The T/L ratio = 5/10 for wine and 8/4 for cheese. 3. False. Since B is land abundant, it has comparative advantage in cheese, the land-intensive product. (the Heckscher-Ohlin theorem) 4. True. Before trade, the relative price of cheese must be lower and the relative price of wine higher in country B than in country A. With trade, the relative prices of the two countries converge. So, the relative price of wine declines with trade. 5. False. As a land-abundant country, B’s wage/rental ratio is higher in autarky than A’s. With trade, the ratio converges and the wage/rental ratio declines in country B. 6. True. (According to the Stolper-Samuelson theorem) the owners of scarce factors of production are worse off with trade. In country B, labor is the scarce factor. Part II. 1. a. 2.5 b. Butter c. $22.5 [$30×(3/4) = $22.5.] 2. Graph 3. The terms of trade (= PB/PC) is 2. Since butter is produced in Germany and cheese in France, PB = 5 × WG (it takes 5 hours to produce a unit of butter) and PC = 4×WF. Combining the two, we obtain 2 = (5 × WG)/( 4×WF). Since WG = $30, it follows that WF = $18.75. 4. In direct production, 1 unit of butter costs 10 hours of work. In indirect production with trade, it takes 2 units of cheese, which cost 8 hours (2×4) to produce.Part III. a. 60 b. 1210 c. 40 d. 570 e. 150 f. 180 g. In a large country, (i) the after-tariff domestic price is lower; (ii) the reduction in imports smaller; (iii) the loss in national welfare is smaller. (It could even gain.) Part IV. 1. According to the gravity model, the volume of trade between two countries is proportional to the product of two countries’ income


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