International Economics

NYU
Fall 2010

HOMEWORK 2. DUE ON OCTOBER 1 S T IN RECITATION.

1.

Answer Question 1 in Gerber Ch. 3

International Economics
NYU
Fall 2010

2.

HARDER. Assume the same technological setup as in 1.

Consider France in autarky. Assume total labor is 20 (L = 20). Preferences for cheese and
0.5
0.5
cars are Cobb-Douglas: U=Qcheese Qcars . What will be the equilibrium in this economy?
(Hint: Find the PPC equation, and recall that for Cobb-Douglas preferences the share of
each good in the budget is given by its coefficient)
There are many ways to find the answer to this question. Because preferences are Cobb-Douglas,
we need to find the budget line for this economy. Alternatively, we can look at Frances
technology, and see that her income is 40 kg of cheese, or 5 cars. That is, the output from the 20
hours of labor available in the economy. We could say it is, for instance, 10kg of cheese and 3.75
cars, but its easier to measure everything in the same units.
Since Frances income is 40 kg of cheese, and income is split evenly across goods, we conclude that
the equilibrium point will be 20kg of cheese, and 2.5 cars.

Consider Germany in autarky. Assume total labor is also 20 (L =20). If German preferences
are the same as French preferences, what would be the autarky equilibrium?

Using an analogous reasoning, we find that Germany consumes 10 kg of cheese, and 5 cars.

International Economics
NYU
Fall 2010
Now countries open up to trade. Plot the PPC for each country. What will be the output
point for each country? Choose one potential free trade price of cheese and plot the trade
line for each country.
These plots are using a price of 5 kg cheese/car (equivalent to one-fifth of a car per kg of cheese.)
cheese

France

Output
point

40

TT

PPC
5

cars

cheese

Germany

TT
20

Output
point
PPC

cars
10

International Economics
NYU
Fall 2010
Find each countrys demand for cars if the price of cars is four kilograms of cheese per car.
How many cars does France demand? How many does Germany demand? What is their
joint demand? What is the total production of cars? Is this an equilibrium price?
Now we have trade, so we measure Frances income as 40 kg of cheese. We could also say it is 10
cars, because that is what its cheese production is worth in the international market. Using the
same reasoning as before, France will demand 20kg of cheese, and 5 cars. Germany will demand 5
cars, and 20kg of cheese (since its 10 cars are worth 20kg of cheese in the world market). So the
joint demand for cars is 10, which equals total car production. This is enough to say that this is an
equilibrium price.
Just to underscore that point, we do not need to check equilibrium in the cheese market. Since cars
are traded for cheese, equilibrium in one market implies equilibrium in the other.
3.

Answer Question 2 in Gerber Ch. 3

e. The trade price of cheese should be between 0.25 car and 1 car.
f. A price of 5kg/car is equivalent to 0.20 car/kg, which is not an equilibrium price. Still, if France follows
her self-interest, the country will specialize in car production.

International Economics
NYU
Fall 2010
4. Answer Questions 1-4 in Gerber Ch. 4.
For Question 3, assume that the conclusions on factor intensity for steel and bread from question 2
are still true, but that we are in a world with variable factor proportions in production. Draw a PPC
for the US and plot the change described in question 3.

Graphically, the important thing to keep in mind is that the trade line should be tangent to the new
production point.

International Economics
NYU
Fall 2010

bread

20

20

5.

30

steel

(Based on Question 10 in Gerber Ch. 4) Suppose Spain were to open its borders to the large number
of unskilled Africans seeking to immigrate.

What effects would you expect to see in Spains trade patterns and comparative advantage?
What effects would you expect to see in factor returns?

Answer by adapting one of the models we have seen so far. Be as formal as possible, and explain
what results you are using to justify your answer. You should include the assumptions of the model,
a proposed (simplified) economy (ie, factors available, factor endowments, goods produced,
technology), and the initial situation under international trade. What are the key assumptions
driving your conclusions?
Many answers are possible. If we think that we are in a small country where capital can move in
and out easily, then we can focus on labor only. Lets say that there is skilled and unskilled labor.
The inflow of unskilled labor can be considered in a Heckscher-Ohlin framework:
1. The Rybczynski theorem tells us that production of goods intensive in unskilled labor will
increase, and production of goods intensive in skilled labor will decrease.
2. Prices will not change! They are, for the most part, international prices, and we are assuming
that Spain cannot affect market prices.
Therefore, we would expect Spains trade patterns to shift towards lower imports of goods intensive
in unskilled labor, and lower exports of goods intensive in skilled labor. If the inflow of immigrants
is high enough, comparative advantage could switch to a point where Spain now exports goods that
it used to import.
Most of you probably have the intuition that this is wrong. You should try and understand why! Is
this what you would expect if you didnt analyze this issue using the HO model?