Question 1 Ricardo

Consider two countries Turkey and Greece with the following unit labor requirements for two products they produce, automobiles and home appliances.

Suppose the labor endowments for Turkey and Greece are 80 and 12 respectively. Also suppose the countries have identical C-D preferences given by U (H, A) =  HαA^1-α

(1) For what values of α the free trade equilibrium is one where countries are completely specialized in their comparative advantage sector?

(2) Take price of autos as the numeraire, that is p_A ≡ 1. Suppose the relative world price P_H/P_A is 2. What is the wage in Turkey and Greece?

(3) Now focus only on Turkey and assume the world price is determined in the rest of the world which is P_H/P_A = 2. Suppose initially that Turkey is under autarky and labor is immobile. Find the real wages in sector H and A in terms of both goods before and after the country opens to trade. Who gains and who loses?

Question 2 Heckscher-Ohlin

Suppose that (1) the United States (US) and China are two countries producing and consuming cloth and microchips. Suppose further that (2) cloth production is labor intensive and China is labor abundant, and (3) microchips production is capital intensive and the US is capital abundant.

(1) Use a Heckscher-Ohlin (H-O) model diagram like below to clearly and accurately show US's and China's autarkic (1) relative price of microchips over cloth, (2) relative factor price R/w, and (3) the relative factor proportions in both the cloth and microchips industries. (Draw them on the same graph.)

(2) Suppose that China and the U.S. now engage in trade. On the same diagram as in part 1 and using a different color pen or pencil than before show US's and China's new (1) relative price of microchips over cloth, (2) relative factor price R/w, and (3) the relative factor proportions in both the cloth and microchips industries.

(3) Provide a brief economic explanation of the results you have shown in your diagrams for parts 1 & 2. Which theorem in the Heckscher-Ohlin framework predicts the result?

(4) Imagine that due the the strict birth control policy, labor force in China declines over time (but suppose that China is still relatively labor abundant compared to US). How does this change affect (1) US TOT; (2) China's TOT; (3) US overall welfare; (4) China's overall welfare; (5) relative factor price R/w? Hint: Apply the analysis in the Standard Trade Model.

(5) Imagine that there is a major breakthrough in microchip production technology. Show its effect on (1) US TOT; (2) China's TOT; (3) US overall welfare; (4) China's overall welfare; (5) relative factor price R/w. Hint: The technological progress affects production in both US and China.

(6) Given your findings in part 5, why does the US government still encourage innovation in the microchip industry in the real world?

Question 3 Trade Wars and Trade Agreements

Consider two large countries, the US and Japan. Suppose each country can unilaterally impose an optimal tariff or choose no protection.

(1) Provide an economic rationale for this payoff matrix.
(a) Find the pure strategy Nash equilibrium of the above matrix.
(b) What is the problem with this equilibrium outcome?
(c) As an advisor for Japan, what suggestions would you offer the country's trade officials when it comes to solving the issue identified in part c?

(2) Now consider 2 small countries, Guatemala and Palau. As in the first section, each country can unilaterally impose a tariff or choose no protection.

(a) Provide an economic rationale for this payoff matrix (your discussion should reference how this payoff matrix differs relative to the large country case).

(b) Find the pure strategy Nash equilibrium of the above matrix.

(c) We often see small countries impose tariffs, what arguments from Chapters 10 and 11 might a small developing country use to validate such actions?

(3) Now suppose we have one large country and one small country, with the following payoff matrix.

(a) Provide an economic rationale for this payoff matrix (your discussion should reference how this payoff matrix differs relative to the other two cases).

(b) Find the pure strategy Nash equilibrium of the above matrix.

(c) What actions could Palau take in response to US actions under the Nash equilib- rium outcome (reference the discussion of Administrative Reforms in Chapter 10 suggest)?

(d) What does the above analysis imply for the prospects of the Doha Development Round (be brief, maximum 3 sentences)?

Question 4 Strategic Trade Policy

(1) There are two competing firms, Boeing in the US and Airbus in France. Both can produce super jumbo jets.

(a) Find all pure strategy Nash equilibria.

(b) What does this outcome imply for the pattern of production across countries? Who will produce in equilibrium?

(2) Suppose the US government decides to provide Boeing with a production subsidy of 100.

(a) Write down the resulting payoff matrix.

(b) Find all new pure strategy Nash equilibria.

(c) What does this outcome imply for the pattern of production across countries? Who will produce in equilibrium?

(d) Suppose Airbus can enter the market first, how does this change your answer to part c?

(e) What hesitations do you have about the US government's ability to influence the equilibrium outcomes? Reference Chapter 12, but be concise.

Question 5 Policy

It is 2004 and Costa Rica is about to form a PTA (preferential trade agreement) with the US. The cost of rice in the US is $10, while it is $8 in Thailand and $12 in Costa Rica.

(1) If the tariff in Costa Rica is $3, what is the impact of the PTA for Costa Rica? Is there trade creation or trade diversion? What is the impact on the price for consumers and the country as a whole?

(2) Redo part 1 but starting with a tariff of $10.

Question 6 Marshallian Externalities

Consider a small open economy with a labor force of 1000 in a world where there are two goods: coffee and medical devices. The unit labor requirement (U LR) in coffee is 2 whereas the U LR in medical devices (MDs) is decreasing because of Marshallian Externalities. In particular, the U LR in MDs is 10 if employment is zero, whereas it falls to 4 when the industry reaches employment above 100. Imagine that the international relative price of MDs in terms of coffee is 3.

(1) Are there multiple equilibria?

(2) Compute the wage in the two equilibrium. Which one is higher?

(3) If the equilibrium is the one with specialization in coffee, does the country gain or lose from trade? Draw the appropriate figure to illustrate your answer. In answering this question, assume that employment in MDs in autarky is above 100.