Exercise 1

Nation 1 has 100 laborers and Nation 2 has 200 laborers. The labor productivity of each nation for bicycles and shoes is given in the table below.

Output per Labor Day

Answer the following questions and justify your answers.

a)    Draw the daily production possibility frontier for each nation, with Bicycles on the vertical axis

b)    Which nation has a higher standard of living before trade? (Assume the population is the same as the number of laborers.)

c)    What is the opportunity cost of Shoes and bicycles in each nation,

d)    Can these two nations, with very different standards of living, beneficially trade with each other?

e)    Suppose now that one laborers in Nation 2 can produce 30 units of Shoes or 30 Bicycles per day. Can these two nations beneficially trade with each other now?

 Exercise 2

The outputs per labourer per day for wine and cheese for France and the U.S. are provided in the table below. Labor is the only input.

Output per Labourer per Day

The current wage rate in France is 40 euros per day, while in the U.S. it is $100 per day. Assume that the current exchange rate is one euro per one U.S. dollar. . Assume constant returns to scale and labor is the only factor of production.

Answer the following questions and justify your answers.

a)            According to the theory of comparative advantage, which of the two counties should import wine from the other?  

b)            Fill in the table below, calculating French prices using the wage rate of 40 euros per day and U.S. prices using the wage rate of $100 per day. With labor as the only input, the price of cheese and wine will equal the cost of labor to produce that cheese if markets are competitive (price equals the average cost of production in competitive markets in the long run). For example, the price of wine in France is 8 euros because one laborers makes 5 units of cheese and one laborers costs 40 euros. (Price = Wage/Production per laborers.)

Price of Wine and Cheese in France and the U.S.

Measured in Euros

c)            Will the low productivity country in this example initially dominate trade as a result of low wages?

d)            Given your answer to c) Is the theory of comparative advantage wrong?

e)            Suppose the exchange rate between France and the U.S. is fixed at one euro per one U.S. dollar and cannot change. Explain why the situation given in the price table above is a disequilibrium situation and how wages and prices will change in France and the U.S.

f)             Now suppose that wages in France and the U.S. cannot change, but the exchange rate is allowed to vary. What will happen to the exchange rate and to prices in the U.S., expressed in euros?

g)            Show that your answers to c) and d) are consistent the theory of comparative advantage

h)            Explain the fallacy in the argument that a nation with high wages (a rich country) cannot mutually beneficially trade with a nation with very low wages (a poor country).

Exercise 3

Consider the following table of marginal productivities of labor. Assume constant returns to scale and labor is the only factor of production.

Output per Labourer per Day

Answer the following questions and justify your answers.

a)    What are the marginal costs in terms of labor of one bushel of wheat and one meter of cloth respectively in each country?

b)    According to the theory of comparative advantage, should the US import both wheat and cloth from Great Britain?  

c)    What is the dollar price of one bushel of wheat and one meter of cloth in the United States if the nominal wage is $6? What is the British Pound price of one bushel of wheat and one meter of cloth in the Great Britain if the nominal wage is £1?

d)    What is the price in US$ of one bushel of wheat and one meter of cloth in Great Britain if the exchange rate is £1 = $2? Would the US be able to export wheat to Great Britain at this exchange rate? Would Great Britain be able to export cloth to the US at this exchange rate?

e)    Are your answers to questions f) consistent with your answer to question c)?

f)      Answer questions f) when the exchange rate is respectively £1 = $4 and £1 = $1.

g)    What is the range of the exchange rate of £1 in terms of US dollar that is consistent with comparative advantage? 

Exercise 4 (optional) 

Answer the following questions. Justify your answers

a)    Explain how is the Ricardian model was tested empirically

b)    To what extent can we assert that the Ricardian model provides a good representation of the real world

c)    Do we need other models?