Homework 3

UCDavis, 160a, SSII 2011Prof. Farshid Mojaver

The Specific Factors Model (questions from Feenstra IT Ch3)

1. Starting from equilibrium in the specific-factors model, suppose the price of manufactured goods falls so that wages fall from W’to W in Figure 3.5 (below).

a.Show that the percentage fall in wages is less than the percentage fall in the price of manufacturing, so that the real wage of labor in terms of manufactured goods goes up.

b.What happens to the real wage of labor in terms of agriculture?

c.Are workers better off, worse off, or is the outcome ambiguous?

2. Read the article by Lori G. Kletzer and Robert E. Litan,“A Prescription to Relieve

Worker Anxiety,” Policy Brief 01-2, Institute for International Economics,Washington,

DC, Then answer the followingquestions.

  1. Under theversion of the Trade Adjustment Assistance(TAA) Act in the United States that they refer to, how many extra weeks of unemployment insurance are workers eligible for? What two criteria must they meet to qualify for this extraunemployment insurance?
  2. Consider the proposal for “wage insurance” that Kletzer and Litan make in theirarticle.What criteria would a worker need to meet to qualify for this insurance?What amount of extra income would they receive from the insurance?
  3. If Kletzer and Litan’s new plan for “wage insurance” had been adopted by theUnited States, what would have been the budgetary cost in 1999 when unemployment was 4.2%? How does this compare with the amount that is now spenton unemployment insurance?

3. Suppose two countries, Canada and Mexico, produce two goods, timber and televisions.Assume that land is specific to timber, capital is specific to televisions, and labor is free to move between the two industries.When Canada and Mexico engage in freetrade, the relative price of televisions falls in Canada and the relative price of timberfalls in Mexico.

  1. In a graph similar to Figure 3-5, show how the wage changes in Canada because of a fall in the price of televisions, holding constant the price of timber. Can wepredict that change in the real wage?
  2. In a graph similar to Figure 3-5, show how the wage changes in Canada because of a fall in the price of televisions, holding constant the price of timber. Can wepredict that change in the real wage?
  3. What is the impact of opening trade on the rentals on capital and land in Canada?Can we predict that change in the real rentals on capital and land?
  4. What is the impact of opening trade on the rentals on capital and land inMexico? Can we predict that change in the real rentals on capital and land?
  5. In each country, has the specific factor in the export industry gained or lost, andhas the specific factor in the import industry gained or lost?

4. Home produces two goods, computers and wheat, where capital is specific to computers, land is specific to wheat, and labor is mobile between the two industries.Home has 100 workers and 100 units of capital, but only 10 units of land.

  1. Draw a graph similar to Figure 3-1, with the output of wheat on the vertical axisand the labor in wheat on the horizontal axis.What is the relationship betweenthe output of wheat and the marginal product of labor in the wheat industry asmore labor is used?
  2. Draw the production possibilities frontier (PPF) for Home with wheat on the horizontal axis and computers on the vertical axis.
  3. Explain how the price of wheat relative to computers is determined in the absence of trade.
  4. Reproduce Figure 3-5 with the amount of labor used in wheat measuring from left to right along the horizontal axis, and the amount of labor used in computersmoving in the reverse direction.
  5. Assume that because of international trade, the price of wheat rises. Analyze the effect of the increase in the price of wheat on the allocation of labor betweenthe two sectors.

Heckshcer-Ohlin Model

Jeopardy Answers

DIRECTIONS: As in the popular TV game show, you are given an answer to a question and you must respond with the question. For example, if the answer is, "a tax on imports", then the correct question is, "What is a tariff?"

  1. term used to describe Argentina if Argentina has more land per unit of capital than Brazil.
  2. term used to describe aluminum production when aluminum production requires more energy per unit of capital than steel production.
  3. general term used to describe the amount of a factor needed to produce one unit of a good.
  4. the two key terms used in the Heckscher-Ohlin model; one to compare industries, the other to compare countries.
  5. term used to describe when the capital-labor ratio in an industry varies with changes in market wages and rents
  6. term describing the ratio of the unit-capital requirement and the unit-labor requirement in production of a good.
  7. the assumption in the Heckscher-Ohlin model about unemployment of capital and labor.
  8. interpretation given for the slope of the production possibility frontier.
  9. the H-O model theorem that would be applied to identify the effects of a tariff on the prices of goods and factors.

Multiple Choice Questions

1. In the 2-factor, 2 good Heckscher-Ohlin model, the two countries differ in:

A. tastes. D. relative availabilities of factors of production.

B. military capabilities. E. labor productivities.

C. size.

2. In the 2-factor, 2 good Heckscher-Ohlin model, a change from autarky (no trade) to trade will benefit the owners of:

A. capital.

B. the relatively abundant factor of production.

C. the relatively scarce factor of production.

D. the relatively inelastic factor of production

E. the factor of production with the largest elasticity of substitution.

3. One way in which the Heckscher-Ohlin model differs from the Ricardo model of comparative advantage is by assuming that ______is (are) identical in all countries.

A. factor of production endowments D. technology

B. scale economies E. opportunity costs

C. factor of production intensities

4. According to the Hecksher-Ohlin model,

A. everyone automatically gains from trade

B. the scarce factor necessarily gains from trade

C. the gainers could compensate the losers and still retain gains.

D. a country gains if its exports have a high value added.

E. None of the above.

5. Starting from an autarky (no-trade) situation with Heckscher-Ohlin model, if Country H is relatively labor abundant, then once trade begins:

A. wages and rents should rise in H.

B. wages and rents should fall in H.

C. wages should rise and rents should fall in H.

D. wages should fall and rents should rise in H.

E. None of the above.

6. Suppose that there are two factors, capital and land, and that the United States is relatively land endowed while the European Union is relatively capital-endowed. According to the Heckscher-Ohlin model,

A. European landowners should support US-European free trade.

B. European capitalists should support US-European free trade.

C. all capitalists in both countries should support free trade.

D. all landowners should support free trade.

E. None of the above.

7. Assume that only two countries, A and B, exist.

Consider the following data: Countries

Factor Endowments A B

Labor Force 45 20

Capital Stock15 10

If good S is capital intensive, then following the Heckscher-Ohlin Theory,

  1. country A will export good S.
  2. country B will export good S.
  3. both countries will export good S.
  4. trade will not occur between these two countries.
  5. Insufficient information is given.

False, True, Or Uncertain, Explain Why (Questions in Heckscher-Ohlin Theory)

Question 1

“Opening up free trade does hurt people in import-competing industries in the short run. But in the long run, when people and resources can move between industries, everybody ends up gaining from free trade.”

Question 2

“American workers gain from free trade with China because free trade lowers prices of clothing in the United States and American workers spent very large portion of their income on clothing”

1. This exercise uses the Heckscher-Ohlin model to predict the direction of trade. Considerthe production of hand-made rugs and assembly line robots in Canada and

India.

  1. Which country would you expect to be relatively labor-abundant, and which capital-abundant? Why?
  2. Which industry would you expect to be relatively labor-intensive, and which is capital-intensive? Why?
  3. Given your answers to (a) and (b), draw production possibilities frontiers for each country. Assuming that consumer preferences are the same in both countries, add indifference curves and relative price lines (without trade) to your PPF graphs. What do the slopes of the price lines tell you about the direction of trade?
  4. Allowing for trade between countries, redraw the graphs and include a “trade triangle”for each country. Identify and label the vertical and horizontal sides of thetriangles as either imports or exports.

2. Leontief ’s Paradox is an example of testing a trade model using actual data observations.If Leontief had observed that the amount of labor needed per $1 million of U.S.exports was 100 instead of 182,would he have reached the same conclusion? Explain.

3.According to the Heckscher-Ohlin model, two countries can equalize wage differencesby either engaging in international trade in goods or allowing skilled and unskilledlabor to freely move between the two countries. Comment.

4. According to the standard Heckscher-Ohlin model with two factors (capital and labor)and two goods, movement of Turkish migrants to Germany would decrease theamount of capital-intensive products produced in Germany. Discuss whether this istrue or false, and explain why.

5. Imagine a two good H-O economy which imports automobiles and exports wheat. Suppose the production of these two goods use only capital and labor. If the government raises a tariff on the import of automobiles it will raise the domestic price of autos. Suppose the price of wheat remains constant. Explain as a result of this tariff who in the economy will gain and who will lose in real terms?

6. Using a HO framework discuss the effects of U.S.-China trade on Skilled-Unskilled wage gap in US and China. Do we actually see these predicted effects on skilled-unskilled wage gaps in the two countries? Are you satisfied with this HO explanation of rising skilled-unskilled wage gap in US?

Questions from Feenstra Ch4

1. This exercise uses the Heckscher-Ohlin model to predict the direction of trade.

Consider the production of hand-made rugs and assembly line robots in Canada and

India.

a.Which country would you expect to be relatively labor-abundant, and which capital-abundant? Why?

b.Which industry would you expect to be relatively labor-intensive, and which iscapital-intensive? Why?

c.Given your answers to (a) and (b), draw production possibilities frontiers for each country. Assuming that consumer preferences are the same in both countries, add indifference curves and relative price lines (without trade) to your PPF graphs.What do the slopes of the price lines tell you about the direction of trade?Canada’s no-trade production and consumption of robots and rugs correspondsto a relative price of robots that is lower than that in India. This is shown by theflatter sloped relative price line in Canada.

d.Allowing for trade between countries, redraw the graphs and include a “trade triangle”for each country. Identify and label the vertical and horizontal sides ofthe triangles as either imports or exports.

2. Suppose that there are drastic technological improvements in shoe production at

Home such that shoe factories can operate almost completely with computer-aided machines. Consider the following data for the Home country:

Computers: Sales revenue =PCQC= 100

Payments to labor = WLC= 50

Payments to capital = RKC= 50

Percentage increase in the price =∆PC/PC= 0%

Shoes: Sales revenue = PSQS= 100

Payments to labor WLS= 5

Payments to capital = RKS= 95

Percentage increase in the price =∆PS/PS= 50%

a.Which industry is capital-intensive? Is this a realistic scenario (i. e., are some industries capital-intensive in some countries and labor-intensive in others)?

b.Given the percentage changes in output prices above, calculate the percentagechange in the rental on capital.

c.How does the magnitude of this change compare with that of labor?

d.Which factor gains in real terms, and which factor loses? Are these results consistentwith the Stolper-Samuelson theorem?

3. In 2008, the Ukraine successfully negotiated terms to become a member of the World Trade Organization. Consequently, countries such as those in Western Europe areshifting toward free trade with the Ukraine. What does the Stolper-Samuelson theorem predict about the impact of the shift on the real wage of unskilled labor in Western

Europe? In the Ukraine?

9. The following are data on U. S. exports and imports in 2007 at the two-digit harmonizedschedule (HS) level. Which products do you think support the Heckscher-Ohlin theory? Which products are inconsistent?

Exports Imports HS Code Products ($ billions) ($ billions)
22 Beverages 3.6 14.7
30 Pharmaceutical products 40.7 55.6
52 Cotton 4.9 0.8
61 Apparel 1.9 33.3
64 Footwear 1.0 17.6
72 Iron and steel 15.4 12.4
74 Copper 5.0 6.4
85 Electric machinery 124.9 212.1
87 Vehicles 73.6 131.9
88 Aircraft 83.0 18.4
94 Furniture 7.0 30.1
95 Toys 7.0 27.6
Source: International Trade Administration, U.S. Department of Commerce.

4.Data for soybean yield, production, and trade are provided below for 2007.

Yield Production Exports Imports
(metric ton/hectare) (100,000 metric ton) (100,000 metric ton) (100,000 metric ton)
Australia 2.44 3.2 0.3 1.0
Brazil 2.81 5785.7 2373.4 9.8
Canada 2.30 269.6 186.8 21.3
China 1.45 1272.5 45.7 3315.0
France 2.60 8.5 1.7 49.4
Ireland 3.13 40.8 2.08.4
Japan 1.64 22.7 0.1 416.1
Mexico 1.41 8.8 0.0 361.1
Russian Federation 0.9265.0 1.7 12.5
United States 2.81 7286.0 2984.0 27.6
Source: Food and Agriculture Organization

Suppose that the countries listed above are engaged in free trade and that soybean production is land intensive. Then answer:

  1. In which countries does land benefit from free trade in soybeans? Explain.
  2. In which countries does land lose from free trade in soybeans? Explain.
  3. In which countries does the move to free trade in soybeans have little or no effect on the land rental? Explain.

5. According to the Heckscher-Ohlin model, two countries can equalize wage differencesby either engaging in international trade in goods or allowing skilled and unskilledlabor to freely move between the two countries. Comment.