International Trade 2011

Exercises Week 1

Christian A. Stoltenberg

Question 1

1) In Home there are 1,200 units of labor available. It can produce two goods, apples and
bananas. The unit labor (lu) requirement in apple production is 3, while in banana
production it is 2.

a) Draw a figure to illustrate Home’s production possibility frontier.

b) What is the opportunity cost of apples measured in bananas?
c) Compute the relative price of apples in the absence of trade?

2) Home is as described in problem 1. There is now also another country, Foreign, with
a labor force of 800. Foreign’s unit labor requirement in apple production is 5, while
in banana production it is 1.

a) Draw a figure to illustrate Foreign’s production possibility frontier.

b) Construct the world relative supply curve.

3) Now suppose world relative demand takes the following form: Demand for ap-
ples/demand for bananas = price of bananas/price of apples.

a) Draw within one figure the world relative supply and demand for apples.
b) Compute the relative price of apples in equilibrium and describe the pattern of
trade.
c) Show that both countries gain from trade.

4) Suppose that instead of 1,200 workers, Home has 2,400. Find the equilibrium relative
price. What can you say about the efficiency of world production and the division of
the gains from trade between Home and Foreign in this case?

Question 2 Consider two countries, A and B, that can produce wine and cheese using
labor as the sole factor of production. The unit labor requirements (measured in hours) of
the two products are specified in the table below.

Cheese Wine
Country A 2 1
Country B 6 3

According to the theory of Ricardo, country A will

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 1. export cheese and wine to country B since it has an absolute productivity advantage
for both products.

2. export wine to country B since the comparative costs of wine in country A are lower
than the comparative costs of cheese.

3. export cheese to country B since the comparative costs of cheese in country A are lower
than the comparative costs of cheese in country B.

4. not export cheese nor export wine since it has no comparative advantage in either of
the products.

Question 3 Assume that the two countries A and B in the initial situation of absence of
international trade, i.e. autarky, both produce olives (o) and beer (b) using only labor. The
unit labor requirements for one pound of olives and one liter of beer are specified in the
below table:
Country A Country B
Olives 4 2
Beer 3 2
The countries decide to open up to international trade with a relative world market price
that yields an exchange of 4/3 liters of beer for one pound of olives. What product(s) will
be produced in both countries if one assumes free trade?

1. Country A completely specializes in the production of olives and country B completely

specializes in the production of beer.

2. Country A completely specializes in the production of beer and country B produces

both products.

3. Countries A and B produce both products.

4. Country B completely specializes in the production of olives and country A produces

both goods.

Question 4 The two countries A and B can produce shrimp and rice with labor being the
only available factor of production. The unit labor requirements for producing one ton of
rice or one kilo of shrimp are:

Country A Country B
Rice 50 40
Shrimp 10 20

After taking up international trade in these two goods, the relative price on the world market
quickly moves to a level that corresponds with that of an exchange of one ton of rice for
four kilo of shrimp. What is your prediction for the wage levels in the two countries after
international trade has generated its effects?

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 1. The wage level in the rice sector in country A is at 1/5th of the wage in the shrimp
sector and the wage in the rice sector in country B amounts to half of that in the
shrimp sector.

2. The wage in country A is larger than the wage in country B.

3. The wage in country A is lower than the wage in country B.

4. The wage in country A equals the wage that prevails in country B.

Question 5 Consider the Ricardian model with two countries (A and B) and two goods (x
and y). Country A can utilize 800 hours of labor, whereas the amount of labor in country B
amounts to 2000 hours. The unit labor requirements per unit of the two goods are specified
as follows:

Country A Country B
x 10 20
y 20 20

The relative demand curve (RD) satisfies the following functional relationship:

world demand for x price for y

=
world demand for y price for x
Which of the following statements is correct?

1. Country A and B completely specialize in the production of x and y, respectively.

2. Country B does not completely specialize in the production of one good.

3. The relative price of y on the world market will be 0.5.

4. The relative world market price of y will be between 1 and 2.

Question 6 The model of Ricardo shows that the advantage that a country can obtain
through engaging in free trade ultimately will depend on the level of the rate of exchange
between its import and its export product. This rate of exchange is determined by world
relative demand and relative supply. In the following question you can assume that the unit
labor requirements remain unchanged and the amount of available labor is equivalent to
the size of the country. In your answer, you should explicitly refer to the terms of trade of
countries (the terms of trade is the ratio of the price of the export good over the price of the
import good).
Use a RS and RD schedule to show that the advantage of international trade for a country
is the largest when

1. a country is larger and when the international preferences for its export good are
relatively large.

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 2. a country is smaller and when the international preferences for its export good are
relatively large.

3. a country is larger and when the international preferences for its export good are
relatively small.

4. a country is smaller and when the international preferences for its import good are
relatively small.

Question 7 The Ricardian model of international trade is based on a number of simplifying

assumptions. Which of the following assumptions is not part of that list?

1. Perfect competition on factor and product markets

2. The production of the goods cannot yield economies of scale

3. The world is characterized by the presence of only one factor of production

4. The model allows for international differences in absolute productivity levels, but not
in relative productivity levels as an impetus for international trade.

Question 8 Consider the Ricardian model with many goods. Specifically, assume that
there are two countries, A and B, that can produce four different types of goods: cheese,
wine, beer, and olives. The unit labor requirements are given by

Cheese Wine Beer Olives

Country A 30 70 15 25
Country B 90 35 60 50

Further, suppose that the wage in country A is twice as high as the wage in country B.
Which statement describes the pattern of trade/production in a correct way?

1. Country A completely specializes in the production of wine.

2. Country A completely specializes in the production of beer and cheese.

3. Country B produces olives and wine, while country A produces cheese, olives and beer.

4. Country B produces cheese and wine, while country A produces beer and olives.

Group Assignment 1 Consider the Ricardian model with many goods. Specifically,
assume that there are two countries, A and B, that can produce five different types of goods:
apples, bananas, caviar, dates and eggs. The unit labor requirements are given by:
Apples Bananas Caviar Dates Eggs
Country A 45 60 70 80 100
Country B 90 80 70 60 50

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Suppose that the wage in country B is 25 percent higher than the wage in country A. Fur-
thermore, there are transportation costs that amount to 30 percent on top of the production
costs. When country A and B trade with each other, country A will:

1. export apples and bananas, import dates and eggs, while caviar is a non-tradable.

2. export apples, import caviar, dates and eggs, while bananas are non-tradables.

3. export apples and bananas, import eggs, while caviar and dates are non-tradables.

4. export apples, import dates and eggs, while bananas and caviar are non-tradables.