INTERNATIONAL TRADE Autumn 2004 NAME: Section: Assignment # 1: Answer key Problem 1 The following Ricardian table shows the number of days of labor input needed to make one unit of output of each of the five commodities in each of the two countries, Brazil and Colombia. Coffee Cocoa Flower Mineral Soccer Ball Brazil 2 days 2 days 4 days 5 days 2 days Colombia 3 days 5 days 2 days 6 days 4 days **1/1/aaaa= = 1.5 2.5 0.5 1.2 2 a. Calculate Brazil s relative productivity for each good and rank the goods according to Brazil s relative productivity advantage from highest to lowest. (fill the first 2 columns below) Name of good Brazil relative productivity advantage No transportation costs With transportation costs 1. Cocoa 2.5 2. Soccer ball 2 3 Coffee 1.5 4. Mineral 1.2 5. Flower 0.5 b. What will be the pattern of trade if the wage rate in Brazil is 100 lbs. cocoa per day while the wage rate in Colombia is 80 lbs. cocoa per day. Brazil s relative wage to Colombia is W/W* = 100/80 = 1.25. If a*/a > W/W* (=1.25), then Brazil exports. If a*/a < W/W* (=1.25), then Brazil imports. Brazil will export Coffee Cocoa Flower Mineral Soccer Ball Brazil will import Coffee Cocoa Flower Mineral Soccer Ball
c. Assume now the existence of costs of transportation equal to 50 lbs. cocoa between the two countries. How will Brazil s pattern of trade change? (use the 3 rd column of the table above to enter Brazil s relative productivity with transportation costs) Using the new information on the transportation cost, we adjust the labor input requirements in the table. Because the transportation cost affects the competitiveness of the exporting country, we add it to the labor costs of export goods. Since W = 100 lbs. cocoa in Brazil and W* = 80 lbs. cocoa in Colombia, the transportation cost of 50 lbs. cocoa, in terms of labor costs, becomes 50/100 = 0.5 day in Brazil and 50/80 = 0.625 day in Colombia. Ricardian table changes as follows: Coffee Cocoa Flower Mineral Soccer Ball Brazil 2.5 days 2.5 days 4 days 5 days 2.5 days Colombia 3 days 5 days 2.625 days 6.625 days 4 days a*/a = 1.2 2 0.66 1.325 1.6 Relative wage W/W* remains the same at 1.25. Name of good Brazil relative productivity advantage No transportation costs With transportation costs 1. Cocoa 2 2 2. Soccer ball 1.2 1.6 3 Coffee 1.5 1.2 4. Mineral 1.2 1.325 5. Flower 0.5 0.66 Brazil will export Coffee Cocoa Flower Mineral Soccer Ball (circle the correct export goods) Brazil will import Coffee Cocoa Flower Mineral Soccer Ball (circle the correct import goods) What is the term used to name goods that are neither imported nor exported because of high transportation costs? Non-tradable 2
Problem 2 Given the following Ricardian type table showing the amount of labor input needed to produce one unit of output in each industry in each country: Rice Bicycle Vietnam 2 days 4 days China 2 days 1 day a. What is the relative autarky price of rice in terms of bicycle in Vietnam? 2/4 = 0.5 b. What is the relative autarky price of rice in terms of bicycle in China? 2/1 = 2 c. Which country has a comparative advantage in rice? Vietnam d. If Vietnam (a small country) has 1,500 days of labor input while China (a large country) has 150,000 days, make an educated guess as to where the terms of trade will settle when the two countries open trade: Pr/Pb = 2 Labor force in China is hundred times larger than that of Vietnam. Although Vietnam fully specializes in the production of rice, it will not be able to produce sufficiently large amount to cover the market in China. It makes China keep producing rice. Since China produces both rice and bicycle, the country s relative price will be kept constant at its autarky price even after it trades with Vietnam. The question is: why would China trade while there are no gains from trade for her (note that China s relative price does not change- PPF and CPF remain the same in one curve). China trades for political reasons, to please her neighbor (Vietnam) who gains from trade. Vietnam fully exploits the gains from trade as the terms of trade settle at the Chinese autarky price (the greatest change possible). Vietnam is a price taker (the Chinese autarky price). Conclusion: small countries should always trade as they have the most to gain. 3
e. Draw the production possibility frontier and the consumption possibility frontier(s) before and after trade for the two countries using the terms of trade you have quoted in d. B Vietnam 1,500 CPF (slope = 2) 375 PPF (slope = 0.5) 750 R B China 150,000 PPF (slope = 2) 75,000 R Report the value of production corresponding to full specialization (intercepts) on the production possibility frontier of each country. 4
Problem 3 Consider a Ricardian model with two goods and three countries. The two goods are olive oil and cheese, and the three countries, Swiss, Spain and Italy. The following table shows the labor input requirements necessary to produce one unit of output. Olive oil Cheese Swiss 3 2 Spain 3 3 Italy 2 4 a. Calculate the relative prices in autarky in the three countries and, if you can, determine their comparative advantage (CA). Po/Pc CA in what? Swiss 1.5 Cheese Spain 1 None Italy 0.5 Olive oil_ b. Let's now focus on Spain and assume various world prices. Can you now complete the table below? if Po/Pc (world) is Spain produces Spain exports 0.75 Cheese Cheese 1 Both Neither 1.25 Olive oil Olive oil c. If you were constructing the world relative supply curve, what would it look like? Sketch it below. Po/Pc 1.5 1 0.5 Qo/Qc 5