Productivity in countries

1) Home and Foreign both produce apples and bananas using only labor. 1 worker working for 1 week (L=1) has the following productivity in each country: Home Foreign 4 Bushels of Bananas 2 Bushels of Bananas 1 Bushel of Apples 1 Bushel of Apples LH = 2000 worker-weeks LF = 1000 worker-weeks • Does either country have an absolute advantage in the production of either good? Explain why or why not. Which good is each country’s comparative advantage? Explain. Remember opportunity cost is a critical piece of your explanation. • Draw each country’s pre-trade production possibilities frontier (PPF), putting Bananas on the y-axis. • Propose terms of trade between these two countries: describe each country’s production/specialization decision, and how the post-trade “exchange rate” between apples and bananas makes both countries better off. Be specific: compare the pre-trade opportunity cost to the terms of trade and show that each country gets a better deal than pre-trade. There is an obvious, easy integer number for terms of trade here. • Include a new line in your PPF graph that represents the new production and terms of trade, and use the graph to show that each country has a better set of consumption choices available after trade. • Discuss how trade changes real wages in each country: compare real wages across countries before trade, and discuss how each country’s wages change after trade. Be sure to cover why one country has higher real wages, and why the real wages change after trade. 2) Our HOME country produces 2 goods: clothing (C) and airplanes (A). Clothing uses labor (L) and Sewing Machines (S), while airplanes uses labor and capital (K). The labor market and both output markets are perfectly competitive: labor is free to move between industries, and the marginal revenue product of labor is the price of output times the marginal product of labor in that industry (P*MPL). HOME recently opened trade with FOREIGN. As a result, we have started importing Clothing, and the price of clothing PC in our HOME market has fallen by 10%. Using the specific factors model, show how the two HOME industries will respond to the lower price of clothing. Specifically, discuss the following points. • For the moment, focus on the initial, pre-trade wage: how has each industry’s profit-maximizing choice of L changed? Given those changes, describe how the wage must change to establish a new full-employment equilibrium in both industries. • Use percentage change logic to discuss how real wages will change (starting with a 10% decline in PC, discuss how the change in nominal wage and the changes in price interact). • Lastly, how do the changes in hiring in the two industries affect the returns to the specific factors (sewing machines and capital)? Discuss both nominal changes and real changes to RS and RK. • Think about your previous answers in terms of winners and losers from opening trade with FOREIGN. Briefly discuss your thoughts on the politics of opening trade: who do you think will support or oppose free trade? 3) Home and Foreign both share the same fixed proportion production technology for shoes and computers: - Labor Capital Shoes 4 Labor per Shoe 1 Machine per Shoe Computers 2 Labor per Computer 3 Machines per Computer Both countries have 400 worker-hours to allocate. Home has 600 machines, while Foreign has 300. Before trade, shoes sell for $40 in each country. The pre-trade price of computers is $30 in Home, but $60 in Foreign. • Based on the information provided, identify the factor intensity of each good (e.g. which good is labor intensive) and the factor abundance of each county. Based on nothing but this information, what pattern of trade would you expect if these countries start trading: who exports which good(s)? • Write down an equation that represent the combinations of shoes and computers that each country can produce using all its capital, and similar equation for using all its labor. Explain why there is a unique combination of shoes and computers that each country will produce. Calculate each country’s production, and draw the graph from class that summarizes all this information. • Briefly discuss Home’s production of computers and shoes in light of your answers about factor abundance and factor intensity. Recall that all firms in a perfectly competitive industry earn zero economics profit in the long run. This implies that Price = Average Total Cost. ATC is just the price to produce one unit of the good here. • Use the P = ATC condition across both industries to solve for the pre-trade wage and rental price of capital in each country. Remember that workers get paid the same wage in either industry, as does capital. • After trade, assume that the price of shoes remains the same, but that the single world price of computers is now $50. How does Home’s wage and rental price of capital change? How about Foreign wages and rents? • Briefly explain the economics of “Factor Price Equalization”: why does it happen? 4) Short answer: “We should stop trading with China: the cheap goods they produce with cheap labor that we buy from them are bad for America” Briefly discuss this statement in light of the theories of trade we have covered. Obviously you could write a lengthy paper on this topic. Keep it short: I’d suggest you think through what “bad for America” looks like in each model. Which model do you think is the best one to use to discuss this? 5) The Heckscher-Olin results are sometimes described as “Trading goods can substitute for trading factors.” Explain this statement in light of your results from Q3. Specifically, • Why might someone describe the pre-trade factor prices and factor abundances as a situation where Home wants to “export capital”? Remember for now you can’t actually export factors. • Post-trade, what hap