Problem Set 1: Ricardo model

Problem solving question (72 points)

Assume the following:

The two countries in the world are the US (Home) and Japan (Foreign)

Each country produces Nintendo Wii's

The unit labor requirements are

The labor supplies are

Dene all the relative variables with

Where relevant, put

= 800
L

on the

(N )

and Rice

(R).

aLR = 5, aLN = 10, aLR = 80, aLN = 20.

and

= 400.
L
R

x axis

in the numerator and

and

on the

in the denominator.

y axis.

Answer the following questions (each part of each question is worth 4 points). Be sure to

clearly label

all relevant features of your diagrams

1. Preliminaries

(a) 4pts.

What is the opportunity cost of producing each good in each country?

(Hint: there should be four opportunity costs).

(b) 4pts. Explain which country has comparative advantage in what good and whether
any country has an absolute advantage.
(c) 4pts. Draw the PPF in each country.

2. Autarky

(a) 4pts.

Suppose that in autarky

QR
QN

A

= 10

and

QR
QN

A

= 5.

Draw the RS

(Relative Supply) and Relative Demand curves for each country and the world.
(b) 4pts. What is the equilibrium price ratio in each country?

(c) 4pts. Explain which one of the following consumption bundles

((DR , DN ) , (DR
, DN
))

is the equilibrium consumption bundle?

i.
ii.
iii.
iv.

800 80
, 6 ,
6


20 100
,
,
21 21


80 800
, 6 ,
6


100 20
,
,
21 21

100 20
,
21 21



800 80
, 6
6



20 100
,
21 21



80 800
, 6
6

(d) 4pts. What are the equilibrium production levels in each country?
(e) 4pts.

Depict the consumption and production points for each country on the

PPF.
(f ) 4pts. What is the wage in each country (i.e.
(g) 4pts. Dene the US real wage as

and

w )?

w
w
and the Japanese real wage as
. What are
pN
pR

these real wages? Are they measured in dollars, units of

or units of

N?

3. Trade

(a) 4pts. Suppose that under trade the equilibrium world price ratio is

pR
pN

world

= 2.

How much does each country produce of each good? What is the relative quantity
consumed in each country?
(b) 4pts. Explain which one of the following consumption bundles

))
, DN
((DR , DN ) , (DR

is the equilibrium consumption bundle?

i.
ii.
iii.
iv.

800 80
, 6 , 100
, 20
6
21 21

160 20


2560 320
,
, 17 , 17
17
17





160 20
320 2560
,
,
,
17 17
17
17

320 2560


20 160
,
, 17 , 17
17 17

(c) 4pts. Depict the consumption and production levels for each good in each country
on your diagram from Q2(e).
(d) 4pts. How much of each good does each country import and export?
(e) 4pts. Does the quantity of world exports equal the quantity of world imports for
each good? Why?

QEX and QEX denote the quantity of exports from each country and
QIM and QIM denote the quantity of imports from each country. Let pEX , pEX ,

pIM and
 pIM
 denote the price of each
 country's exported and imported good.
pEX
pEX
Does
QEX = QIM and p
QEX = QIM ? Why?
pIM

(f ) 4pts. Let

IM

(g) 4pts.

What is the wage in each country?

Explain which country has a cost

advantage in what good.

(h) 4pts. What is the real wage in each country?

Paragraph response question (25 points)

The following quote appeared in an opinion peice on time.com by a former chairman of the
US International Trade Commission (actually, one of your classmates forwarded this article
to me):
The United States has the world's largest economy, but it isn't the best producer of
everything. People would do well to bury their tribalism and realize it is OK to buy and
enjoy imports [from low wage countries]. When it comes to the politics of trade, Americans
should resist their evolutionary tendencies toward self-suciency and instead allow open
markets to work their magic.

You should give a brief concise response (not more

than one paragraph) to this statement based on the theory of the Ricardo model.

Extra credit (15 points)

While neither country loses from trade in the Ricardo model, the gains from trade are not
necessarily distributed evenly between countries. That is, one country may reap nearly all
of the global gains from trade and the other country may only receive a small share of these
global gains from trade.
Using the world relative demand and relative supply diagram and the expressions for real
wages, show how the realtive size of countries aects how countries split the global gains
from trade.