1. Study the following table, which shows the maximum output of beer and chips that the US and Mexico can produce under constant cost conditions (recall from lecture that constant cost conditions means that the production possibility frontier will be linear; by contrast increasing
costs means the production possibility frontier will have a curved shape).
Product US Mexico
Beer 36,000 15,000
Chips 6,000 5,000
(a) Graph the production possibilities frontiers for Mexico and the US. In the absence of trade, assume that the US produces and consumes 24,000 beers and 2,000 chips; Mexico produces and consumes 7,500 beers and 2,500 chips. Indicate these points on each country's production possibilities frontiers.
(b) Determine the domestic relative price ratio for each country (note: this is the same as the marginal rate of transformation between these two goods). Explain as clearly as you can how to interpret this domestic relative price ratio using both terms of the marginal rate of transformation and opportunity costs.
(c) According to comparative advantage, should the two countries specialize and trade with one another? Explain your answer in reference to relative price ratios. If they do trade, which country should specialize in the production of which product? Once specialization has occurred, what is the increase in world output?
(d) Suppose that the international price ratio (i.e. the "terms of trade") is 1 chip for 5 beers. Assume that 2,000 chips are traded for 10,000 beers. Are the consumers in the US and Mexico better off? If so, by exactly how much?
(e) Suppose that the international price ratio has shifted (due a shift in global demand) to 1 chip for 4 beers. Has global demand in the world for chips relative to beers gone up or down? Assume that 2,000 chips are traded at the new terms of trade for 8,000 beers. Are the consumers in the US and Mexico better off? If so, by exactly how much?
(f) Give your results from the preceding parts, summarize how the relationship between the international price ratio and the domestic price ratios determines how the gains from trade are shared among trading partners.
2. Traditional trade theory, such as the Ricardian or Factor Proportions Model, is based on six crucial assumptions, which may or may not be valid for any particular country, sector, or factor of production. What are these assumptions and how might they be violated in the real world
of international trade? Support your answer for each assumption with specific examples from current developed or developing countries.
3. Traditional trade theory is basically a static theory of international exchange (i.e. it only focuses on a point in time) leading to certain conclusions about the benefits likely to accrue to all participants. Explain both the limitations of this static perspective and discuss why dynamic elements are important (i.e. "dynamic" means refers to trade policy and openness over time).
Provide two specific historical examples (other than the examples given in class from Korea, the US, and England) that illustrate your points about how good trade policy might differ if we have a dynamic rather than just static perspective. (Hint: the Ha-Joon Chang chapters from Bad Samaritans will help you immensely with this problem.)
4. Explain the Logic of Collective Action. Use this logic to explain a major US or international policy issue of your choice (it could either be a policy that successfully passed or one that failed to pass).