Exemplary Writers

# Homework (Ch 03)

## 1. Visualizing the factor-endowment theory

Consider the two hypothetical nations of Grork and Ferville. Suppose they both produce only two goods, robot vacuum cleaners and plastic army men. Each country faces a trade-off when producing the two goods. The following graph displays the respective production possibilities frontiers (PPF) for Grork and Ferville.
If the two nations operate in autarky, which of the black points (plus symbol) are attainable for Ferville? Check all that apply.
Points:
1 / 1
Close Explanation
Explanation:
When a nation operates in autarky, it is choosing to produce on its own without trade. That means that the only bundles it can produce are those that fall on or inside its PPF. In this case, point C is attainable to both nations, since it falls inside both Ferville’s blue PPF and Grork’s orange PPF. Point A is only attainable for Ferville, since it falls inside its PPF, but outside Grork’s. When operating in autarky, point D is not attainable for Ferville, since it is outside of its PPF. However, since point D falls on Grork’s PPF, it is attainable for that nation in autarky. Point B is outside both nations’ individual PPFs, and therefore, neither country can attain it in autarky. (Note: At points inside their respective PPFs, both countries could improve their situations by consuming more of both goods while still staying inside their PPFs.)
Suppose the two nations decide to trade with each other at a rate of one robot vacuum cleaner per plastic army man (1:1).
On the previous graph, use the green line (triangle symbol) to represent the terms of trade to help you find your answer to the following question. You will not be graded on where you place the line on the graph.
Which of the grey points (star symbol) that were not attainable by either country in autarky are attainable once the countries agree to trade, holding all else constant? Check all that apply.
Points:
1 / 1
Close Explanation
Explanation:
When the two nations trade with each other, some points that were unattainable in autarky (because they were beyond each country’s respective PPF) become possible consumption bundles. To see which bundles can be consumed with trade, you must now consider the terms of trade agreed on between the two countries. In this case, Grork and Ferville agree to trade one robot vacuum cleaner for one plastic army man; thus, the appropriate terms-of-trade line has a slope of –1. In addition, it must also be tangent to both PPFs because only the points on each PPF use all of a nation’s resources.
Since point Y was attainable by both nations in autarky, it does not represent a gained consumption possibility due to trade. On the other hand, points Z and X were both unattainable in autarky, but because they fall on or inside the terms-of-trade line, they become possible consumption bundles once both countries specialize and realize gains from trade. Finally, even with trade, point W remains unattainable, since it lies outside the terms of trade line.
Suppose Ferville and Grork engage in trade, and both nations desire the same post-trade consumption bundle. (Note: Assume both countries will not waste any resources.)
Grork willimport   robot vacuum cleaners.
Points:
1 / 1
Close Explanation
Explanation:
When the two nations agree to trade, they will each specialize and focus their production on the good that they can produce more efficiently. Based on the shape of the PPFs, you can see that Ferville gives up more robot vacuum cleaners to produce one more plastic army man than Grork does. This means that Grork will focus on producing plastic army men and export them in exchange for robot vacuum cleaners imported from Ferville.

## 2. Factor-price equalization

The fictional country of Tomczakistan is a nation that is relatively rich in labor resources. It can produce two types of goods, capital-intensive goods and labor-intensive goods. Tomczakistan’s production possibilities frontier (PPF) is shown on the following graph.
Currently, Tomczakistan is closed to international trade and producing at the grey point (star symbol) labeled A on the graph. Suppose that Tomczakistan is going to trade with Leightvania, a country that is relatively rich in capital and was also previously closed to international trade.
On the following graph, use the green point (triangle symbol) to indicate which way Tomczakistan will adjust its production by placing it on one of the two black points (plus symbol). Dashed droplines will automatically extend to both axes.
Points:
0 / 1
Close Explanation
Explanation:
When a labor-rich country like Tomczakistan begins trading, it will specialize by producing more of the goods that need its abundant resource (labor), and produce less of the goods that need its trading partner’s abundant resource (capital). Tomczakistan changes its production to focus more on the type of goods it can produce most efficiently, in this case, labor-intensive goods. Its trading partner (the capital-rich Leightvania) will specialize by producing more of the other goods, in this case, capital-intensive goods. Graphically, Tomczakistan’s specialization is a movement up and to the left along the production possibilities frontier, increasing the number of labor-intensive goods Tomczakistan makes and decreasing the number of capital-intensive goods it produces.
Once trade begins, the price of capital in Tomczakistandecreases   . In Leightvania, the price of capitalincreases   .
Points:
1 / 1
Close Explanation
Explanation:
Before trade, the price of capital in labor-rich countries is relatively high, since capital is relatively scarce. As a country like Tomczakistan specializes and focuses on using less capital and more labor in production, Tomczakistan’s demand for capital and, therefore, its price of capital, decreases.
On the other hand, before trade, the price of capital in capital-rich countries is relatively low, since capital is so common. As a country like Leightvania focuses on producing more capital-intensive goods as a part of specialization, it will have higher demand for its capital, driving the price of capital up. These price changes will continue until the price of capital is equal in both countries.

Suppose Germany signs a free trade agreement with Russia. As a result, Germany’s exports of cars (which are intensive in capital) and its imports of timber (which are intensive in land) both increase.
According to the Heckscher-Ohlin theory, Germany is abundant incapital   .
Points:
1 / 1
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Explanation:
According to the Heckscher-Ohlin theory, a country exports goods that intensively use the factor of production in which the country is relatively abundant. Since Germany exports cars, whose production is capital intensive, the theory suggests that Germany is abundant in capital.
Consistent with the Heckscher-Ohlin theory and the Stolper-Samuelson theorem, which of the following groups in Germany will support its free trade agreement with Russia? Check all that apply.
Points:
0.75 / 1
Close Explanation
Explanation:
The Stolper-Samuelson theorem predicts that an increase in the relative price of a good will increase the real earnings of the factor used intensively in the production of that good and decrease the real earnings of the other factors. On the other hand, a decrease in the relative price of a good will have the opposite effect. When Germany increases its exports of cars and its imports of timber, the relative price of cars in terms of other goods rises, and the relative price of timber falls. Therefore, the earnings of capital, in which cars are intensive, increase, so capital owners will support Germany’s free trade agreement with Russia. However, the earnings of land, which is used intensively to produce timber, fall, so landowners will oppose free trade.
The Heckscher-Ohlin theory assumes that all factors are mobile, so their earnings are equalized across industries, which means gains and losses of the factor owners are not specific to industries. The Heckscher-Ohlin theory also shows that free trade allows consumers to reach a higher level of utility, so it predicts consumers’ support of Germany’s free trade agreement with Russia.

## 4. Resolution of the Leontief paradox

The factor-endowment theory predicts that because the United States is relatively abundant in capital and relatively scarce in labor, it will export capital-intensive goods, and its import-competing goods will be labor intensive. In the 1950s, Wassily Leontief, a Russian-American economist, tested this proposition by analyzing the capital/labor ratios of export industries and import-competing industries, using U.S. data. He found that the capital/labor ratio for U.S. export industries was lower than that of the United States’ import-competing industries, which means that U.S. exports were less capital intensive than import-competing goods. These findings appeared to contradict the predictions of the factor-endowment theory and became known as the Leontief paradox.
Replicate Leontief’s test using the data shown in the following table. Compute the capital/labor ratio for exports and imports, and enter each value in the last column of the table.
Used to Produce $1 Million Worth of . . . Capital Labor Capital/Labor Ratio (Dollars) (Person-years) (Dollars per person-year) Exports 1,600,000 125 12,800 Imports 2,300,000 115 20,000 Points: 1 / 1 The numbers in the previous table show that U.S. exports arelabor intensive , and U.S. imports arecapital intensive . Points: 1 / 1 What do the results of your test illustrate? Check all that apply. Points: 1 / 1 Close Explanation Explanation: The capital/labor ratio for U.S. exports is$1,600,000125 person-years=$12,800 per person-year$1,600,000125 person-years=$12,800 per person-year. The capital/labor ratio for imports is$2,300,000115 person-years=$20,000 per person-year$2,300,000115 person-years=$20,000 per person-year. Since the capital/labor ratio for exports is less than that for imports, U.S. exports are labor intensive, and U.S. imports are capital intensive. The Heckscher-Ohlin theory states that a country will export goods that intensively use the factor of production that is relatively abundant in that country, and it will import goods that intensively use the factor of production that is relatively scarce in that country. Since the United States has more capital per worker than does the rest of the world, the theory states that U.S. exports must be capital intensive and imports must be labor intensive. Leontief’s test, however, showed the opposite: The capital-labor ratio for U.S. imports was higher than that for U.S. exports. The data in the table lead to the same conclusion. Which of the following explanations resolve the Leontief paradox? Check all that apply. Points: 0.25 / 1 Close Explanation Explanation: Leontief included not just two but many exported and imported goods in his test and correctly assumed, while interpreting his results, that the United States was relatively abundant in capital. Explanations of the Leontief paradox are mainly about the problem that some assumptions of the Heckscher-Ohlin model don’t hold in the real world. In contrast to what the model assumes, U.S. and foreign technologies are not the same. And including only labor and capital as factors of production in the model is an oversimplification, as other factors (such as land) are used to produce U.S. exports and imports. Further, if the test distinguished between skilled and unskilled labor, it would not be surprising to find that U.S. exports are intensive in skilled labor. Also, the United States was not engaged in completely free trade, as the Heckscher-Ohlin theory assumes. Finally, one explanation for the paradox is that the data for 1947, which Leontief used, may be unusual because World War II had ended just two years earlier. ## 5. Why similar countries trade Consider two hypothetical countries called Cassvania and Koopmansville. The countries have similar production technology, and yet they specialize and trade with each other. Read the following details and determine why international trade is possible between these two countries. Cassvania has many more universities than Koopmansville. The top scientists who graduate in Cassvania are very happy there and typically do not want to move. As a result, there are many more research scientists looking for work in Cassvania, making it cheaper to hire them there than in Koopmansville. Because of this, many pharmaceutical companies are established in Cassvania to be close to a cheaper labor source. Cassvania produces important prescription drugs and exports them. Despite their similarities, Cassvania and Koopmansville are able to trade because ofexternal economies of scale. Points: 1 / 1 Close Explanation Explanation: Even though Cassvania and Koopmansville have similar resources and technology, there are ways they can benefit from international trade. When industries become concentrated in one country because that country has a specific resource, the specialization is due to external economies of scale. The specialization isn’t due to anything one country offers for that industry that the other doesn’t. Instead, it is because a different (or external) market unique to one nation makes it easier for the industry to operate in one country over another. As a result, it becomes cheaper for a firm to produce a good in the country that has been better at producing this good overall. ## 6. Violations of the factor-endowment theory of trade While different natural resources and the theory of comparative advantage can explain many trade patterns, they cannot explain all types of trade that economists observe. Consider each scenario in the following table and determine which theory best explains the trade pattern described. Scenario Dynamic Comparative Advantage Product Life Cycle Theory Intra-Industry Specialization For many years, the nation of Catchester has found it challenging to compete internationally in the market for crab because dangerous work conditions have steered many successful fisherfolk toward safer and more stable careers. In order to attract workers, the Catchester government passed a law providing life insurance policies to all Catchester crab industry workers. This successfully incentivized many former fisherfolk to return to the seas for a career in crab fishing. Catchester is now able to compete more effectively on a global scale and has become a major international exporter of crab. Ice wine is a special spirit that can only be made during a few months in the winter. The nations of Fruzenton and Grappovia are in different hemispheres, and each produces ice wine. During each nation’s winter, its ice wine industry produces enough to meet domestic demand and export to the other country. The ice wine exchanged between the two nations is nearly identical. For many years, microchip firms in the nation of Tablon have struggled with high production costs compared to firms in the nation of Ghovia, because Tablon’s soldering tools are outdated, forcing workers to work slowly. As a result, most microchips are made in Ghovia and exported. An inventor employed by a firm in Tablon comes up with a new way to solder chips that makes workers 40% more efficient. This innovation reduces costs and allows the firms in Tablon to take over the microchip market. In response, firms in Ghovia start to research how they can update their factories to be more cost effective. Points: 1 / 1 Close Explanation Explanation: Intra-industry specialization leads to a different type of trade than other international trade models predict. Rather than seeing different industries establish themselves in a single nation, firms in many countries continue to make the same goods, but different varieties of those goods. This sort of trade can be observed, even when products are not differentiated, if it can be cheaper to import a good than to get it domestically. One common example would be if two countries with different climates exchange the same crop because it can only be grown seasonally. In this case, even though both Fruzenton and Grappovia produce the same good, they cannot produce it at the same time. This sort of climate difference gives the nations a reason to trade, even though both can produce an identical good. This type of trade is an example of intra-industry specialization. The product life cycle theory explains that the location of an industry changes over time as companies are forced to innovate. Once a technological innovation is discovered in one nation, its firms will gain a comparative advantage and begin to dominate the market and export. As firms in other nations lose market share, they will be forced to focus on research to get business back. After they make a new discovery, production will shift. This theory relaxes the assumption that the Heckscher-Ohlin theory makes: Technology is held constant across time. In this case, the innovation in Tablon advanced the product life cycle. The newly discovered soldering technology in Tablon gave firms there a temporary comparative advantage that stimulated demand for exports. As firms in Tablon gained market power, firms in Ghovia saw their microchips reach the end of their life cycle, and the demand for exports fell. To make future profits, firms in Ghovia will need to research their own valuable technology that will give them a new comparative advantage in the marketplace. When trade is stimulated by rounds of research and innovation, it is explained by the product life cycle theory. Dynamic comparative advantage occurs when countries actively try to change or enhance one of their sources of comparative advantage. This change can come from the private sector or the government when it engages in industrial policy. In this case, the Catchester government realized that its crab fishing industry was hurting because good workers were fleeing for safer occupations. By enacting laws to make crab fishing more desirable, the Catchester government encouraged skilled workers into this industry, giving its firms a comparative advantage. When trade is stimulated by a country actively attempting to change its comparative advantage, that sort of trade is described by the model of dynamic comparative advantage. Moreover, when the government takes an active role to create the new comparative advantage, this is called industrial policy. ## 7. Transportation costs and comparative advantage The following graph shows a fictional world economy that consists of only two countries, Glako and Borville. Both countries produce airplanes under increasing-cost conditions. Note that the left-hand part of the diagram is a mirror image of a standard supply-demand diagram, and therefore the supply and demand curves slope in directions opposite their usual directions. In the absence of trade (that is, autarky), the equilibrium price in Glako is$4,000

, and the equilibrium price in Borville is

$8,000 . (Hint: Enter all monetary values in full. For example,$7,000 rather than $7.) Points: 1 / 1 In the absence of trade, which of the following statements is correct? Points: 1 / 1 Close Explanation Explanation: In the absence of trade, the intersection of a country’s domestic demand curve and supply curve for a good determines the country’s autarky price. In this case, Glako’s autarky price is$4,000, and Borville’s autarky price is $8,000. Because the autarky equilibrium price of airplanes in Glako is$4,000, which is lower than that of Borville ($8,000), Borville has the comparative disadvantage in production of airplanes. Now suppose both countries open up to international trade with each other. For each country, use the previous graph to compute the equalizing price, consumption and production at that price, and the quantity of exports and imports when there are no transportation costs. Enter these amounts into the first two rows of the following table. Equalizing Price Consumption at Equalizing Price Production at Equalizing Price Exports Imports (Dollars) (Airplanes) (Airplanes) (Airplanes) (Airplanes) Without Transportation Costs Glako 4,000 4 4 4 0 Borville 8,000 4 4 0 4 With Transportation Costs Glako 12,000 4 4 4 0 Borville 16,000 4 4 0 4 Points: 0.3 / 1 Close Explanation Explanation: When trade is allowed, Glako will produce more airplanes, and Borville will produce fewer airplanes compared to without trade because Borville has the comparative disadvantage in production of airplanes. Under increasing-cost conditions, Glako’s cost and price levels rise, and Borville’s price falls. The equalizing price is the price at which the basis for further trade growth is eliminated. This occurs at$6,000. At this price, the excess supply of airplanes in Glako just matches the excess demand in Borville. Glako will consume two airplanes and produce six airplanes, and Borville will consume six airplanes and produce two airplanes. Thus, Glako will export four airplanes, and Borville will import four airplanes.
The following graph shows the effects of international trade between Glako and Borville when no transportation costs are present:
Now suppose that the per-unit cost of transporting a airplane between Glako and Borville is $2,000. For each country, use the previous graph to compute the equalizing price, consumption and production at that price, and the quantity of exports and imports when transportation costs equal$2,000. Enter these amounts into the last two rows of the previous table.
Close Explanation
Explanation:
When the per-unit cost of transporting one airplane from Glako to Borville is $2,000, Glako’s export price is the domestic production cost plus the cost of transporting one airplane to Borville. In this case, Glako will produce and export airplanes to Borville until its relative price advantage is eliminated. The basis for trade is eliminated when Glako’s price plus the transportation cost rises to equal Borville’s price. This equalization occurs when Glako’s price rises to$7,000 and Borville’s price falls to $5,000. Note that when transportation costs are included in the analysis, the two countries’ domestic prices differ by the amount of the transportation cost, so each country now has its own domestic airplane price. At$5,000 per airplane, Glako will produce five airplanes and consume three airplanes. At $7,000 per airplane, Borville will produce three airplanes and consume five airplanes. Therefore, Glako’s exports of two airplanes will equal Borville’s imports. The following graph shows the effects of international trade between Glako and Borville when transportation costs are$2,000 per airplane:
Compare free trade in the absence of transportation costs with the case when transportation costs are included.
Which of the following statements about how the trade between Glako and Borville differs in the presence of transportation costs relative to trade when then are no transportation costs are correct? Check all that apply.
Points:
1 / 1
Close Explanation
Explanation:
Compared with free trade in the absence of transportation costs, when transportation costs are included, the high-cost importing country will produce more, consume less, and import less; the low-cost exporting country will produce less, consume more, and export less. In this case, Glako is a low-cost exporting country, and Borville is a high-cost importing country. Borville will produce more (three airplanes instead of two), consume less (five airplanes instead of six), and import less (two airplanes instead of four), while Glako will produce less (five airplanes instead of six), consume less (three airplanes instead of two), and export less (two airplanes instead of four).
Overall, transportation costs reduce the volume of trade, the degree of specialization in production among the trading nations, and the gains from trade.

## 7. Transportation costs and comparative advantage

The following graph shows a fictional world economy that consists of only two countries, Greenberg and Baxton. Both countries produce cars under increasing-cost conditions. Note that the left-hand part of the diagram is a mirror image of a standard supply-demand diagram, and therefore the supply and demand curves slope in directions opposite their usual directions.
In the absence of trade (that is, autarky), the equilibrium price in Greenberg is

$8 , and the equilibrium price in Baxton is$4

. (Hint: Enter all monetary values in full. For example, $7,000 rather than$7.)

Points:
0 / 1
In the absence of trade, which of the following statements is correct?
Points:
0 / 1
Close Explanation
Explanation:
In the absence of trade, the intersection of a country’s domestic demand curve and supply curve for a good determines the country’s autarky price. In this case, Greenberg’s autarky price is $8,000, and Baxton’s autarky price is$4,000. Because the autarky equilibrium price of cars in Baxton is $4,000, which is lower than that of Greenberg ($8,000), Greenberg has the comparative disadvantage in production of cars.
Now suppose both countries open up to international trade with each other.
For each country, use the previous graph to compute the equalizing price, consumption and production at that price, and the quantity of exports and imports when there are no transportation costs. Enter these amounts into the first two rows of the following table.
Equalizing Price
Consumption at Equalizing Price
Production at Equalizing Price
Exports
Imports
(Dollars)
(Cars)
(Cars)
(Cars)
(Cars)
Without Transportation Costs
Greenberg
6
8
2
0
6
Baxton
6
2
8
6
0
With Transportation Costs
Greenberg
7
6
3
0
3
Baxton
5
3
6
3
0
Points:
0.8 / 1
Close Explanation
Explanation:
When trade is allowed, Baxton will produce more cars, and Greenberg will produce fewer cars compared to without trade because Greenberg has the comparative disadvantage in production of cars. Under increasing-cost conditions, Baxton’s cost and price levels rise, and Greenberg’s price falls. The equalizing price is the price at which the basis for further trade growth is eliminated. This occurs at $6,000. At this price, the excess supply of cars in Baxton just matches the excess demand in Greenberg. Greenberg will consume eight cars and produce two cars, and Baxton will consume two cars and produce eight cars. Thus, Baxton will export six cars, and Greenberg will import six cars. The following graph shows the effects of international trade between Greenberg and Baxton when no transportation costs are present: Now suppose that the per-unit cost of transporting a car between Greenberg and Baxton is$2,000.
For each country, use the previous graph to compute the equalizing price, consumption and production at that price, and the quantity of exports and imports when transportation costs equal $2,000. Enter these amounts into the last two rows of the previous table. Close Explanation Explanation: When the per-unit cost of transporting one car from Baxton to Greenberg is$2,000, Baxton’s export price is the domestic production cost plus the cost of transporting one car to Greenberg. In this case, Baxton will produce and export cars to Greenberg until its relative price advantage is eliminated. The basis for trade is eliminated when Baxton’s price plus the transportation cost rises to equal Greenberg’s price. This equalization occurs when Baxton’s price rises to $5,000 and Greenberg’s price falls to$7,000. Note that when transportation costs are included in the analysis, the two countries’ domestic prices differ by the amount of the transportation cost, so each country now has its own domestic car price.
At $7,000 per car, Baxton will produce three cars and consume six cars. At$5,000 per car, Greenberg will produce six cars and consume three cars. Therefore, Baxton’s exports of three cars will equal Greenberg’s imports.
The following graph shows the effects of international trade between Greenberg and Baxton when transportation costs are \$2,000 per car:
Compare free trade in the absence of transportation costs with the case when transportation costs are included.
Which of the following statements about how the trade between Greenberg and Baxton differs in the presence of transportation costs relative to trade when then are no transportation costs are correct? Check all that apply.
Points:
1 / 1
Close Explanation
Explanation:
Compared with free trade in the absence of transportation costs, when transportation costs are included, the high-cost importing country will produce more, consume less, and import less; the low-cost exporting country will produce less, consume more, and export less. In this case, Greenberg is a high-cost importing country, and Baxton is a low-cost exporting country. Baxton will produce less (six cars instead of eight), consume more (three cars instead of two), and export less (three cars instead of six), while Greenberg will produce more (three cars instead of two), consume less (six cars instead of eight), and import less (three cars instead of six).
Overall, transportation costs reduce the volume of trade, the degree of specialization in production among the trading nations, and the gains from trade.

## 8. The factor-price equalization theory and transportation costs

Which of the following statements about the factor-price equalization theory and the effects of transportation costs are correct? Check all that apply.
Points:
1 / 1
Close Explanation
Explanation:
The factor-endowment theory makes a number of assumptions that may not hold in the real world. The theory assumes perfect competition, identical production conditions for each product in the trading countries, free movement of resources within a country but not between countries, and no transportation costs nor barriers to trade. The factor-endowment theory predicts that when nations engage in free trade, the cheap resource becomes relatively more expensive, and the expensive resource becomes relatively less expensive, until price equalization occurs.
In reality, there are significant differences in transportation costs across countries, which prevent product prices from equalizing. They act as sources of comparative advantage and affect the volume and composition of trade. In general, when trade is in equilibrium, the price of the traded product in the exporting nation is less than the price in the importing country by the amount of the transportation cost.
Which of the following statements about transportation costs are correct? Check all that apply.
Points:
1 / 1
Close Explanation
Explanation:
From 1965 to the first decade of the 2000s, transportation costs, as a percentage of the value of all U.S. imports, decreased from 10% to less than 4%. As a result, imports became more competitive in U.S. markets, which contributed to a higher volume of trade for the United States. Falling transportation costs have been due largely to technological improvements, such as the development of large dry-bulk containers, large-scale tankers, containerization, and wide-bodied jets. Technological advances in telecommunications have also reduced the economic distances between nations.
Rising shipping costs suggest that trade should be both dampened and diverted as markets look for shorter, less costly transportation routes. When transportation costs rise, markets tend to substitute goods that are from closer locations rather than from locations halfway around the world carrying inflated shipping costs.