Professor Fernando Parro

Fall 2017

International Trade Theory

Practice Midterm

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Instructions:

Total: 100 points.

Time allocated: 2 hours 30 minutes.

Please label the axes in your graphs.

Please show your work in the space provided below each question.

Please write neatly.

GOOD LUCK!

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 Part I. Short questions (50 points)
Please answer TRUE, FALSE or UNCERTAIN and explain the reasoning behind your answer.
No credit will be given for answers that do not have explanations. Please feel free to include a
figure as part of your explanation if you think it will help clarify your argument. Please restrict
your answers to the models developed in the course.

1- (8 points). Consider a standard Ricardian model with two countries, two goods and a single
factor of production, labor, which can freely move between sectors within a country but is
immobile internationally. An increase in the productivity of one of the countrys comparative
disadvantage sector has no effect on a trading countrys real wages.

2- (8 points). In the Ricardian model with free trade, changes in absolute advantage have no effect
on welfare as long as comparative advantages do not change.

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3- (8 points). According the Stolper-Samuelson theorem, the scarce factor in any given country
will lose from international trade.

4- (8 points). Countries whose factors have the same marginal products in each industry have no
incentive to trade.

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5- (8 points). In the HO model, immigration from the labor abundant country lowers the relative
wage of labor in the capital abundant country.

6- (8 points). A flow of capital from one small open economy to another due to a trade
liberalization agreement (e.g., the NAFTA between the Canada and Mexico) will cause
production of the receiving countrys more capital-intensive industry to increase and production
of the receiving countrys more labor-intensive industry to decrease. Assume no change in
industry prices.

7- (2 points). The HO model is a good model to study the slow labor relocation across industries
that we observe in the data after an increase in import competition from foreign countries. You
dont need to provide an explanation for this question, just mark True or False.
True False

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 Part I. Ricardo (25 points)

The following table shows the total possible output per 20 days of labor input in each of the two
commodities in each of the two counties (assuming all labor is used in each respective sector):

Motorcycles (M) Software (S)

China 200 600
India 40 800

a) (2 points). Which country has absolute advantage in the production of motorcycles? How about
software?

b) (2 points). How many days of labor are needed to produce 1 motorcycle in China?

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c) (2 points). What is the opportunity cost of producing 1 piece of software in India?

d) (2 points). Which country has comparative advantage in the production of software?

Motorcycles?

e) (2 points). Which good is going to be produced in China, and which good in India under free
trade? What is going to be the pattern of trade?

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f) (7 points). Find the interval in which the relative price of software must fall for trade to be
mutually beneficial. Discuss in detail why countries gain from trade in this case.

g) (8 points). Authorities in China are evaluating the possibility of signing a free trade agreement
with the United States instead of trading with India? What is your evaluation of this proposal?
Which elements you would take into consideration?

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Part III. Heckscher-Ohlin (25 points)
Consider the simple Heckscher-Ohlin model discussed in class, with two countries, two goods
and two factors. The two countries are Japan and China, the two factors are capital and labor, and
the two goods are petroleum and textiles. Assume that Japan is a capital abundant country, and
China is a labor abundant country.

a) (5 points). Under free trade, Japan is producing more petroleum relative to textiles compared
with China. Based on this information, what do you know about the factor intensities of the
petroleum and textiles industries? Using the Lerner diagram, show the equilibrium allocation of
capital and labor in each industry in each country.

b) (2 points). Describe the patterns of trade under free trade.

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c) (5 points). China has developed a program that has resulted in a large increase in investment
and capital accumulation in the country. What is the effect of this program on wages of Chinese
workers? Explain.

d) (5 points). China is actually losing its export advantage in its comparative advantage sector.
Could it be related to the development of the infrastructure program? Is China as a whole
necessarily worse off as a result of this program?

e) (5 points). How are the wages of Japanese workers relative to the wages of Chines workers
after trade liberalization? Why could this prediction of the HO model be so unrealistic, i.e. far
from what we see in the data?