Homework -

Q1. The Ricardian model Consider two countries, Spain and Russia, producing two goods, Vodka and Wine. Labor is the only production factor, and to produce one liter of wine two hours of work are required in Spain, and five in Russia. At the same time, to produce un liter of Vodka, two hours of labor are needed both in Spain and in Russia. Wages in Spain are 50% higher than in Russia.

(a) What is the cost of producing wine in Spain compared to Russia? What is the cost of producing Vodka in Spain compared to Russia?

(b) Assuming zero transportation costs, if trade is liberalized between Spain and Russia which country will specialize in the production of Wine? Which one in the production of Vodka? Why?

(c) Assume now that transportation costs are equal to 100% of the initial production cost of the good. What will happen to the trade flows between Spain and Russia? Provide an analytical answer to this question.

Q2. The specific factors model Pasqua, a small island in the Pacific produces two goods, potatoes and fish. Potatoes are produces using land and labor, while fish is fished in the Ocean by fishermen renting fishing boats. Assuming that workers can freely move between the potato and the fishing industry, answer the following questions.

(a) Graphically illustrate the labor market equilibrium in Pasqua. Clearly identify the functions you are plotting, the equilibrium wage rate and the labor allocation between the two sectors.

(b) Following a storm, several fishing boats have sunk, but fortunately no fisherman has actually died. What are the effects of the storm on Pasqua's labor market? Clearly illustrate the new equilibrium and analyze the effects of the reduction in the number of fishing boats on the well being of workers and land owners. Derive the result using also the analytical framework we have developed in class (hat algebra).

(c) Consider now an alternative scenario. After several years of lobbying, Pasqua's potato growers have finally managed to convince the government that a tariff should be imposed on potatoes imported from the rest of the world. Graphically illustrate the effects of this trade restriction on the labor market equilibrium. Who benefits from the introduction of this policy? Who loses? Derive the result using also the analytical framework we have developed in class (hat algebra).

3. Stolper-Samuelson Suppose that the production functions of sector 1 and 2 are Q₁ = K₁^0.3L₁^0.7 and Q₂ = K₂^0.6L₂^0.4, respectively.

(a) Determine which of the goods is capital intensive.

(b) Derive the unit cost functions to produce good 1 and 2.

(c) If the prices of goods 1 and 2 are 1 and 1, make use of the unit cost functions to derive the wage and rental rates, assuming that both goods are produced.

(d) State the Stolper Samuelson theorem.

(e) If the price of good 1 increases to 2 while that of good 2 remains constant, derive the new wage and rental rates. By comparing your results in (c) and (e), argue that the Stolper-Samuleson theorem holds.