Mark description: This assignment is marked out of 40, which corresponds to 40% of the overall assessment mark for this subject. Marks within questions are distributed according to the detail provided. Please answer all questions.
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Ricardian Model of Trade
Question 1 – Ricardian Model of Trade 15 marks (3+3+3+3+3)
Suppose two economies Home (H) and Foreign (F) produce two goods, bread and wine, with only one production factor: labour. Production technology, expressed in unit labour requirements, are given in the following table:
|Units of labour required to produce one unit of output||Bread||Wine|
Suppose that Home has 2400 units of labour and Foreign has 1800 units of labour.
- (3 marks) Derive the Production Possibilities Frontier (PPF) and the Consumption Possibility Frontier (CPF) for Home and Foreign, with bread on the horizontal axis and wine on the vertical axis. What is the autarky equilibrium price of bred relative to wine in each country?
- (3 marks) What country has the absolute advantage in producing each good? What country has the comparative advantage in producing each good? Briefly explain the difference between these two concepts.
- (3 marks) Suppose both countries are now free to trade. Draw a graph depicting the global market of bread and wine with the relative price of bread on the vertical access and the relative quantity of bread on the horizontal axis. Assume the relative demand curve (RD) is given and it intersects the relative supply curve (RS) at a relative price of bread of 1. Note that this is a point in between the two relative prices in autarky in each country.
- (3 marks) Now suppose these countries trade with each at the equilibrium relative world price of bread. What is the pattern of specialisation and trade? Why?
- (3 marks) To the graphs you drew in point (a) add the CPF after free trade. Which country gains from free trade according to Ricardian Model. Why?
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Specific Factors Model of Trade
Question 2 – Specific Factors Model of Trade 10 marks (2+1+2+1+2+2)
Assume France can produce 2 goods Airplanes and Wine using labour (L) that is mobile between the 2 sectors. Capital machinery (K) is specific to producing airplanes. Vineyards (V) are specific to producing wine.
- (2 marks) Use a single diagram to show how French labour (L) is allocated between airplanes and wine. This is the combined graph with the wage curves for each sector. Hint: The graph should represent both wages which are a function of MPL and prices.
- (1 mark) What conditions must be met for the labour allocation to be a stable equilibrium, i.e., that both products are produced while France remains in autarky? Clearly identify the equilibrium in the diagram.
Now assume France engages in free trade and in the world market the price of wine is 10% lower than in France, while the price of airplanes does not change.
- (2 marks) Redraw the diagram in point (a) and let the price of wine fall by 10%.
- (1 mark) What happens to the labour demand curves in the airplane sector and in the wine sector?
- (2 marks) What happens to the allocation of labour and why?
- (2 marks) Who wins and who loses in France after opening to trade? Briefly explain.
The Heckscher-Ohlin Model of Trade
Question 3 – The Heckscher-Ohlin Model of Trade 10 marks (3+3+1+3)
Assume two economies Germany (GER) and Cambodia (CAM) produce cars (C) and rice (R) using two factors, capital (K) and labour (L), which are mobile across sectors. Cars production is capital intensive and rice production is labour intensive. Further, Germany has 120 units of labour and 120 units of capital, while Cambodia has 100 units of labour and 80 units of capital. The cost of labour is w. The cost of capital is r.
- (3 marks) Which country is capital abundant relative to the other country? Explain why.
- (3 marks) In the diagram below, draw the relative supply of cars/rice for each country in autarky. Explain any difference across countries. (Hint: Remember that relative prices reflect opportunity costs).
Also read: Free Trade versus Fair Trade Policy Debate Q & A
Now, suppose Germany and Cambodia are free to trade.
- (1 mark) In the graph depicted in point (b) above mark the approximate relative price under free trade. Describe the patterns of specialisation and trade.
- (3 marks) At free trade relative price, does Germany produce more or fewer cars relative to rice in comparison with autarky? Does Cambodia produce more or fewer cars relative to rice in comparison to autarky? Mark these points of production at free trade price on the graph depicted in point (b).
Multiple-choice Questions 5 marks (1+1+1+1+1)
*No justification required.
- The effect of trade on specialised employees of exporting industries will be ____ jobs and ____ pay because they are relatively____.
- A) fewer, lower, mobile
- B) more, higher, mobile
- C) more, lower, immobile
- D) fewer, lower, immobile
- E) more, higher, immobile
- The Ricardian model of international trade demonstrates that trade can be mutually beneficial. Why, then, do governments restrict imports of some goods?
- A) Imports are only restricted when foreign made goods do not meet domestic standard of quality
- B) Import restrictions are the results of trade wars between hostile countries
- C) Trade can have substantial effects on a country’s distribution of income
- D) The Ricardian model is often incorrect in its prediction that trade can be mutually beneficial
- E) Restriction on Imports are intended to benefit domestic consumers.
- In the specific factor model, a country’s production function is ____ because of ____.
- A) a curved line, constant marginal returns
- B) a curved line, a limited supply of labour
- C) a curved line, diminishing marginal returns
- D) a straight line, constant marginal returns
- E) a straight line, diminishing marginal returns
- The effect of trade on income distribution
- A) is insignificant in the short run
- B) is positive for all segments of an economy
- C) can be significant in the short run
- D) implies that there are no real gains from trade
- E) refutes the model of comparative advantage
- Engaging in free trade usually leads to a process of production specialisation within country that causes winners and losers. Governments
- A) Should ignore the losers and focus on the winners
- B) Should design and implement policies to compensate the losers and facilitate their transition to another sector/activity
- C) Should avoid opening to free trade when the losers (or potential losers) have strong lobby power or have representatives in the government
- D) Should rely on the good will and initiative of the winners to compensate the losers