Answer 3.pdf

ECON 22061 Principles of Macroeconomics Instructor: Jooyoun Park Fall 2009 Study Questions for Lecture 3 Lecture 3 Gains from Trade Study Questions: Answers A. Absolute Advantage and Comparative Advantage Each of the tables shows the unit labor requirement for two goods, X and Y, in two countries, A and B. These are the only goods, and the only countries, in the world. In each case, fill in the blanks with one of the following: X, Y, A, B, Both , Neither Sorry about the typo! The last choice should be ?Neither,? not ?Either.? a. Country A has an absolute advantage in good __neither___ Good A B Country B has comparative advantage in good ____X_____ X 30 20 Y 1.6 1.2 **Absolute Advantage: Good X: 30 > 20. So, Country B (which requires 20 hours to make one unit of X, compared to A?s 30 hours) has an absolute advantage in good X. Good Y: 1.6 > 1.2. So, Country B (which requires 1.2 hours to make one unit of X, compared to A?s 1.6 hours) has an absolute advantage in good Y. **Comparative Advantage: A uses 30 hours to make one unit of good X. With that 30 hours, A can make 30/1.6 (=18.75) units of Y. That is, opportunity cost of good X in country A is 18.75 units of good Y. B uses 20 hours to make one unit of good X. With that 20 hours, B can make 20/1.2 (=16.67) units of Y. That is, opportunity Cost of good X in country B is 16.67 units of good Y. ? Country B has a lower opportunity cost of X; so, country B has a comparative advantage in good X. ? That means country A has a comparative advantage in good Y. ** Trade Pattern: Trade pattern is determined by the pattern of comparative advantage. Good X: Country B has a C.A. in good X, so country B exports. Good Y: Country A has a C.A. in good Y, so country A exports. ECON 22061 Principles of Macroeconomics Instructor: Jooyoun Park Fall 2009 Study Questions for Lecture 3 b. Country with an absolute advantage in good X ____B_____ Good A B Country with a comparative advantage in good Y ____A____ X 330 310 Y 9800 9800 **Absolute Advantage: Good X: 330 > 310. So, Country B has an absolute advantage in good X. Good Y: 9800=9800. So, neither country has an absolute advantage in good Y. **Comparative Advantage: Opportunity cost of good X in country A is 330/9800 = 0.0337. Opportunity cost of good X in country B is 310/9800 = 0.0316. (LOWER) ? Country B has a comparative advantage in good X. Country A has a C.A. in good Y. ** Trade Pattern: Good X: Country B has a C.A. in good X, so country B exports. Good Y: Country A has a C.A. in good Y, so country A exports. c. Country that exports good X ______B____ Good A B Country that exports good Y ______A____ X 30 20 Y 1.6 1.2 Sorry, this is same as part (a) d. Country A has an absolute advantage in good ____Both____ Good A B Country B has comparative advantage in good ____Y______ X 0.01 0.02 Y 0.03 0.04 **Absolute Advantage: Good X: 0.01 < 0.02. So, Country A has an absolute advantage in good X. Good Y: 0.03 < 0.04. So, Country A has an absolute advantage in good Y. **Comparative Advantage: Opportunity cost of good X in country A is 0.01/0.03 = 0.333. (LOWER) Opportunity cost of good X in country B is 0.02/0.04 = 0.5. ? Country A has a comparative advantage in good X. Country B has a C.A. in good Y. ** Trade Pattern: Good X: Country A has a C.A. in good X, so country A exports. Good Y: Country B has a C.A. in good Y, so country B exports. ECON 22061 Principles of Macroeconomics Instructor: Jooyoun Park Fall 2009 Study Questions for Lecture 3 B. Trade and Wage The table below shows the unit labor requirements for five goods in two countries, X and Y. Country X Country Y Ratio Turnips (hr/lb) 14 8 14/8 = 1.75 Elbow grease (hr/qt) 42 35 42/35 = 1.2 Fish netting (hr/yd) 140 70 140/70 = 2.0 Nicotine patches (hr/100) 33 30 33/30 = 1.1 Pianos (hr/piano) 1200 960 1200/960=1.25 a. For each good, calculate the ratio of the unit labor requirement in Country X to that in Country Y. Record it in the far right column. Answers in the table. Note that the ratio represent the relative productivity of country Y. If ratio is high (as for fish netting), country X needs much more workers than country Y, meaning country Y?s relative productivity (compared to country X) is the highest in fish netting production. b. Suppose now that in the absence of any trade, the wage of labor in Country X is $4/hr and the wage in Country Y is $10/hr. Fill in the table below with the autarky prices of each good in each country. Country X Country Y Turnips (hr/lb) 14 x $4 = $56 8 x $10 = $80 Elbow grease (hr/qt) 42 x $4 = $168 35 x $10 = $350 Fish netting (hr/yd) 140 x $4 = $560 70 x $10 = $700 Nicotine patches (hr/100) 33 x $4 = $132 30 x $10 = $300 Pianos (hr/piano) 1200 x $4 = $4800 960 x $10 = $9600 c. If the wage in Country X is fixed, in what direction must the wage in Country Y change, if the two countries open to free trade, in order for both countries to have something that they can export to the other? All goods from country Y are more expensive than those from country X. Country Y?s wage must fall. What are the highest and the lowest wages that can prevail in Country Y with free trade, given the $4/hr wage in Country X? The highest wage level will be the wage with which price of one good in country Y is equal to the price in country X. If wage is $9 in country Y, all goods are still more expensive in country Y. If wage is $8 in country Y, Fish netting price is $560 in both countries. So, the highest wage that can prevail in country Y with free trade is $8. How do we know which good?s price will be equalized at the highest level of country Y?s wage? The good in which country Y has the highest relative productivity, fish netting (with the highest ratio!). ECON 22061 Principles of Macroeconomics Instructor: Jooyoun Park Fall 2009 Study Questions for Lecture 3 The lowest wage level will be the wage with which prices of four goods in country Y are less than the prices in country X, and one good has the same price in two countries. If wage in country Y is slightly less this level, all prices will be lower in country Y, so free trade is not sustainable. Which good?s price needs to be equal with the lowest wage level in country Y? The good in which country Y has the lowest relative productivity, nicotine patches (with the lowest ratio!). The price of nicotine patches is $132 in country Y, so price in country Y = 30 x wage =132. Therefore, the minimum level of wage in country Y with free trade = $4.40 For which of the five goods can you predict with certainty the pattern of trade? Which direction does the trade occurs, that is who exports those goods and who imports them? We know for sure that country X exports nicotine patches (the lowest ratio) and country Y exports fish netting (the highest ratio). Trade pattern of other goods depend on the wage level. d. Suppose that a free trade equilibrium is achieved with a $4/hr wage in Country X and a wage exactly half way between the minimum and maximum that you found in part (c). Fill in the table below with the world prices of each good and the name of the country that will export it. The minimum and maximum wage rate in country Y is $4.4/hr and $8/hr. So, the wage half way between these two values = $6.2/hr. Country X Country Y World Price Exported by Turnips (hr/lb) $56 8 x $6.2 = $49.6 $49.6 Y Elbow grease (hr/qt) $168 35 x $6.2 = $217 $168 X Fish netting (hr/yd) $560 70 x $6.2 = $434 $434 Y Nicotine patches (hr/100) $132 30 x $6.2 = $186 $132 X Pianos (hr/piano) $4800 960 x $6.2 = $5952 $4800 X The world price is the lower price among two. The country with lower price has a comparative advantage in that good, so exports. C. Terminology Define the following terms: a. Opportunity Cost: the amount of alternative that you need to give up in order to obtain one unit of this item. b. Autarky: The situation of not engaging in international trade; self-sufficiency c. Absolute Advantage: The ability to produce a good using fewer inputs than another producer d. Comparative Advantage: The ability to produce a good at a lower opportunity cost than another producer. Jooyoun Park