Deadline: Submit by 6pm, Oct. 9th 2020

Homework 1
ECON2252 Theory of International Trade
Deadline: Submit by 6pm, Oct. 9th 2020.
Submission Channels: Electronically only via Moodle. Our TA will set up the link soon.
Format: type version is encouraged. Handwriting-and-scan version is acceptable.
Remark 1 This problem set helps you review the Ricardian model. You may discuss in groups,
with each group up to 5 students. But you need to write down your homework by yourself.
1. Regarding Ricardian Model:
(a) State the economic questions it asks, the key model assumptions, and key predictions of the model.
(b) Now think like an empirical trade economists. If you are going to provide empirical evidence to test Ricardian model, what are you going to test? Explain why it is a good test of Ricardian model. List at least three tests to the model. [NOTE: Be innovative and do not limit to the lecture notes.]
2. In the 2 goods 2 countries case, explain the welfare gains from a simple Ricardian model.
Refer to Slide 15 in the lecture note “2 1RicardianModel.pdf”:
(a) In the complete specialization case (when relative demand is RD), what are the gains from international trade for each country? Use the changes in consumption possibility frontier (CPF), similar to that on slide 16, to illustrate the idea.
(b) In the incomplete specialization case (when relative demand is RD’ in the figure on slide
15), what are the gains from international trade for each country? Use the changes in consumption possibility frontier (CPF), similar to that on slide 16, to illustrate the idea.
In particular, does Home country have gains from international trade given that it still produces both products after trade? [We thank a student for asking this great question in class.]
3. Based on the insight of Ricardian model, please comment on the following claims with a solid argument: high wage countries cannot compete with developing countries who has lower wage rates.
4. (Ricardian Model: Autarky Economy) Two countries, Home and Foreign, use one factor,
labor, to produce two goods, Shoes and Computers. The Home country can produce Shoes with 1 unit of labor and Computers with 2 units of labor. The Foreign country can produce
Shoes with 4 units of labor and Computers with 5 units of labor. Home country is endowed with a labor force of 200 units, while Foreign country is endowed with a labor force of 100
units. Preferences are the same in the two countries and are described by the following utility function: U (S, C) = 0.5 ln S + 0.5 ln C, where S and C refer to the consumption quantity of shoes and computers, respectively.
(a) Which country has an absolute advantage in producing Shoes? Which country has an absolute advantage in producing Computers?
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(b) Which country has a comparative advantage in producing Shoes? Explain in words why this is the relevant information to determine the pattern of production in an economy where the two countries are allowed to trade.
(c) What is the pattern of production and consumption in the Home country when in autarky?
i. Draw the graph of the production possibility frontier (PPF) and indifference curves in one graph for the Home country. Show how the PPF and indifference curves determine the equilibrium point in the graph.
ii. Please find the equilibrium relative prices of the two goods, wage rates, consumption of each goods, and allocation of workers between the two industries in the Home country. [Note: slightly more difficult.]
(d) What is the pattern of production and consumption in the Foreign country when in autarky?
i. Draw the graph of the production possibility frontier (PPF) and some indifference curves in one graph for the Foreign country. Show how the PPF and indifference curves determine the equilibrium point in the graph.
ii. Please find the equilibrium relative prices of the two goods, wage rates, consumption of each goods, and allocation of workers between the two industries in the Foreign country. [Note: slightly more difficult.]
5. (Ricardian Model: trade) Consider the above two countries. Now imagine the two countries are allowed to trade.
(a) Draw the world relative supply curve. For which range of prices will both countries specialize? What happens if the price is not in this range?
(b) Now write down the relative demand function for the world.
i. Use the relative demand and relative supply in the world, find the relative price of the two products in the world after trade.
ii. Draw the world relative demand curve and world relative supply curve on the same graph, and show the equilibrium after trade.
iii. What are the wage rates in each country after trade?
(c) Does your answer of specialization and trade correspond to your explanation for question
(b) regarding comparative advantage?
(d) Draw the new consumption possibility frontier after trade for each country. Explain what is the source of gains from trade in this problem.
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