Department of Economics
ECON 302
International Trade
Semester 1, 2002
MID-SEMESTER TEST
Thursday, May 2nd, 7.00-8.30pm
Answer questions one and two in the answer book provided. Each
question is worth 25 marks.
Use of calculators
Calculators may be used in this test. Calculators must be non-
programmable, hand-held, and without alphabeticized key pads.
Please make sure there are 5 pages included in this test.
-1-
1. Consider trade between two countries, Advanced and Backward. Each
country is capable of producing two goods, torches (T) and yachts (Y).
Labour is the only factor of production, of which Advanced has 200 units and
Backward 100 units.
Table 1.1 displays unit input requirements (how many units of labour are
required to produce one unit of output) in each country for each good.
Table 1.1
Unit labour requirements
Advanced Backward
Torches 1 2
Yachts 5 20
(a) What is the opportunity cost of producing each good in each country?
(2 mark)
(b) Define absolute advantage. Which country has an absolute advantage in
which good(s)? (2 marks)
(c) Define comparative advantage. Which country has a comparative
advantage in which good(s)? (2 marks)
(d) Draw a production possibilities frontier for each country (measure the
production of yachts on your vertical axis). Be sure to label intercepts and
indicate slopes. Also, add “normally-shaped” community indifference
curves to your diagram and illustrate production and consumption in each
country. (3 marks)
(e) What is the relative price of yachts in each country in autarky? What is the
relative price of torches in each country in autarky? (1 mark)
(f) Suppose Advanced and Backward engage in free trade. Determine upper
and lower limits for [PY/PT]tt (the relative price of yachts at which the
countries will trade) and derive the world relative supply curve. Put the
relative price of yachts (PY/PT) on your vertical axis and the relative
quantity of yachts (QY/QT) on your horizontal axis. Be sure to label
intercepts and kink points and include a commentary in your analysis.
(5 marks)
(g) Suppose that [PY/PT]tt is equal to 7. Add a relative demand curve to your
diagram in (f) consistent with this fact. Also, using diagrams similar to
those in (d), illustrate the unrestricted trade equilibrium in each country.
Be sure to label intercepts, indicate slopes, and identify imports and
exports in both diagrams. Do both countries gain from trade? Why or why
not?
(5 marks)
-2-
(h) Confirm the gains/losses from trade to each country by calculating the real
wage in terms of each good (how many units of each good a unit of labour
could purchase if it only consumed one good) in each country when (i)
there is no trade, and (ii) there is unrestricted trade at the relative price
[PY/PT]tt = 7. (i.e. copy and complete the following tables). Why do your
calculations indicate that there are gains/losses from trade?
(5 marks)
Table 1.2
Real wages in autarky
Real wage in terms of: Advanced Backward
Torches
Yachts
Table 1.3
Real wages in free trade
Real wage in terms of: Advanced Backward
Torches
Yachts
-3-
2. (a) Assume that Austria and Belgium have identical production
…..possibilities frontiers for producing chocolate and sausage, and face
…..increasing opportunity costs in production. Residents of Austria prefer
…..to consume large amounts of chocolate and small amounts of sausages.
…..Residents of Belgium prefer to consume large amounts of sausages and
…..small amounts of chocolate.
(i) If technologies are identical in the two countries, what condition
will result in identical production possibilities frontiers?
(1 mark)
(ii) Illustrate the autarky equilibria in each country using a suitable
diagram (measure the production of sausages on your vertical
axis). Be sure to identify production and consumption of each
good in each country. (3 marks)
(iii) Which country has a comparative advantage in chocolate? Which
country has a comparative advantage in sausages? Explain.
(2 marks)
(iv) Assuming that there is unrestricted trade, determine upper and
lower limits for the relative price of chocolate at which the two
countries will trade, [PC/PS]tt. Explain. (2 marks)
(v) On a suitable diagram, draw offer curves for the two countries
(measure trade in sausages on your vertical axis) and use your
diagram to identify each nation’s imports and exports, and [PC/Ps]tt.
(4 marks)
(vi) Illustrate the gains/losses from trade by adding trade indifference
curves to your diagram in (v). (3 marks)
(b) Krugman’s model of monopolistic competition is described by the
following equations (in standard notation):
nF
AC = c (CC)
S
1
P c (PP)
nb
(i) What happens to average cost as the number of firms in the
industry increases? Explain. (2 marks)
(ii) What happens to price as the number of firms in the industry
increases? Explain. (2 marks)
-4-
Televisions are produced by a monopolistically competitive industry as
described by Krugman that faces a demand curve with demand parameter
b = 1/8000. Fixed costs are $4,000,000 and marginal costs are $500.
Televisions are produced in two countries, Argentina and Brazil.
Argentina has annual sales of 32,000, and Brazil has annual sales of
40,500.
(iii) Determine the equilibrium number of firms and the price of
Televisions in each country in autarky. (2 marks)
(iv) Suppose that Argentina and Brazil engage in free trade. Determine
the equilibrium number of firms and the price of televisions in the
integrated market. Are there gains from trade? Why or why not?
(2 marks)
(v) Now suppose that Argentina and Brazil integrate with a third
country, Chile, which has annual sales of 24,500 televisions.
Determine the equilibrium number of firms and the price of
televisions in the new integrated market. Is the new equilibrium
superior to that in (iv)? Why or why not? (2 marks)
-5-