Solution to problem set 5.

3 in Advanced International Trade by Feenstra

Found on www.easytradesolutions.wordpress.com

Problem set 5.3

a)

Using MR=MC for both industries we have:

p1(1-1/σ) = θp1 = c1(w, r),

p2 = c2(w, r).

In the first of these two equations above, we use the assumption of a large number of goods so that the
elasticity of demand equals σ, with θ=(σ-1/σ). When we totally differentiate these equations, we will obtain
the standard Stolper Samuelson results.

b)

The full-employment conditions can be derived from demands for factors from one unit of industry
output Ny1, where N is the number of firms in industry 1:

a1L = L1/Ny1 = [(c1wy1N + αc1wN)/Ny1] , with c1w = ∂c1/∂w

so that,

a1L = c1w(1 + α/y1), and a1K = c1r(1 + α/y1).

Then the full-employment conditions are written as,

a1L(Ny1) + a2Ly2 = L
a1K(Ny1) + a2Ky2 = K

Then Rybczynski Theorem holds for changes in (L, K) affecting (N, y2), with y1 fixed.

c)

Changing the fixed costs will have no impact on the above results. Given that factor prices are determined
in (a), we need to modify the definition of the demand for factors in (b), but analogous full-employment
conditions will still hold.