Assignment:
You should try to solve the question by yourselves. If you struggle, don't stay stuck for too long (too long is not 5 mins!), but work and discuss the problem with other students in small groups. Once you have figured a potential solution, write up your solution individually.
Exercise 1 State whether the following statements are true, false, or uncertain, and briefly give the reason for your answers. The explanation is more important than the correct classification.
a. The broad pattern of globalization among developed economies is best described as a steady increase since the late 19th century.
b. According to standard trade models, removing barriers to trade necessarily makes everyone better off.
c. According to standard trade models, if one country wins from trade, another country must lose.
d. Countries with identical preferences and identical endowments never trade.
e. Countries with different preferences and different endowments always trade.
Exercise 2 A country ("Home") is populated with workers who produce either food (F) or clothing (C). There are 300 workers producing food and 100 producing clothing - these numbers are fixed in the short run. Each food worker produces 5 units of food and each clothing worker produces 3 units of clothing. Workers own the output they produce and can trade with another.
All workers share the same preferences over food and clothing represented by the utility function:
U(DC, DF ) = D2CDF
a. What is the autarky trade price (the relative price of food and clothing) in this economy? Hint: recall the property of Cobb-Douglas utility functions relating expenditure shares on both goods.
b. In autarky, how many units of food and clothing will be consumed by a clothing worker? By a food worker?
c. There also exists another country ("Foreign") that looks surprisingly like the Home country except that there are 300 food workers and 500 clothing workers in this country. These workers have different (lower) productivity levels: a food worker can produce only 2 unit of food while a clothing worker can only produce 1 units of clothing. The workers in Foreign share the same preferences as those in Home. Answer questions (a) and (b) for the Foreign economy in autarky.
d. Compare the consumption levels of workers in both countries. What explains the differences between countries?
e. Now assume that these 2 countries open to trade with one-another.
i. What will be the free trade relative price of food and clothing?
ii. Describe the pattern of trade (who exports what, and how much). Verify that the export supply matches the import demand for both goods.
iii. Calculate the new consumption levels of both types of workers in both countries.
iv. For each type of worker in both countries, asses whether they are better-off in the new trade equilibrium. Could you have predicted this pattern before calculating the new consumption levels and the free trade price equilibrium? How?
v. Now assume that all workers belong to representative "families". The representative "families" at Home contain 3 food workers and 1 clothing worker. The representative "families" at Foreign contain 3 food workers and 5 clothing worker. Describe how the consumption patterns (the number of units of food and clothing consumed) of the "families" change between autarky and the trade equilibrium. Are the "families" in both countries unambiguously better-off? Why should you not be surprised by this result?
f. Without redoing the calculations in (e), describe how your answers would change if the productivity of both types of Foreign workers were multiplied by 5. In particular, what will happen to:
i. The pattern of trade (what good is exported by each country)
ii. The distribution of the gains from trade: - Which workers will gain from trade? - What will happen to the "families" of workers in each country?
iii. What will be the most noticeable impact of this higher Foreign productivity? If the productivity increase was such that the free trade price remains unaffected, what would be the effect of the productivity increase on workers in Home?
g. Return to the trade equilibrium described in (e). If workers can switch occupations in the long run, what will happen to the number of workers in each industry (only describe the direction - not the magnitude - of the change)?