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Problem Set 1 (PART B)

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36 views1 page

Problem Set 1 (PART B)

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100517679
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UC3M

INTERNATIONAL TRADE
Problem Set 1 (Part B)

INSTRUCTIONS - This pair of similar exercises go thru the main results from Ricardian Model. Notice that the first
exercise is very similar to the one we did in class, but with a slight change: less workers in Cuba (probably by now
most of you know why I did that change).

1. Suppose that Cuba and Montserrat, two Caribbean island economies start trading with each other. There are
two goods in the economy: sugarcane and mangoes. The unit labour requirements for sugarcane are 5 and 4
respectively for Cuba and Montserrat. The unit labour requirements for mangoes are 20 and 10 respectively for
Cuba and Montserrat. The total labour force in Cuba is 750 and it is 500 in Montserrat.

a) In which good(s) does Cuba have an absolute advantage? In which does it have a comparative advantage?
Who will be exporting what in a free trade equilibrium?
b) Draw the supply and demand schedules for mangoes relative to sugarcane for the economy as a whole i.e.
taking both countries together. Note that the relative supply curve can be determined with precision while
the representation of the demand curve is slightly random (something that we will change in the following
question).
c) Assume that both countries have identical preferences and represented by a Cobb-Douglas utility function
where U (x, y) = x1/2 y 1/2 and x represents the quantity consumed of good x. Find the equilibrium equili-
brium prices under free trade. (HINT: We prove in class how the relative demand looks like with this type
of preferences, then use that result).
d ) For each country find the equilibrium quantities: export, imports, production and consumption
e) Determine the wage level in Cuba relative to the wage level in Montserrat.Why would Montserrat want to
trade with cuba if the latter is simply taking advantage of the former?s lower wages? Is there a contradiction
between free and fair trade?

2. Consider two countries, Home and Foreign and two goods apples and bananas. In the Home country the unit
labour requirements for apples and bananas are respectively 3 and 2. In the Foreign country the unit labour
requirements for apples and bananas are 5 and 1 respectively. The Home country has a labour force of 1200 and
the Foreign country has a labour force of 800.

a) Graph the Production Possibility Frontiers for each of the two countries. What are the prices of apples in
terms of bananas in both countries in the absence of trade? Why?
b) Construct the world relative supply function.
c) Suppose that the world relative demand takes the following form: demand for apples/demand for bananas
= banana price/apple price. Draw the world relative de- mand curve superimposed on the world relative
supply curve. What is the equilibrium relative price of apples under free trade?
d ) Describe the pattern of trade. Show that each of the two countries gain from trade.
e) Suppose that instead of 1200 workers the Home country has a labour force of 2400. Find the equilibrium
relative price. What can you say about the division of gains from trade between the two countries.

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