Solutions – Seminar 6
2 a)
Labor required
One computer
One sack of rice
in N
10
15
in S
40
20
The revenue from adding an extra worker to the computer industry is
Pc/10 while the revenue from adding an extra worker to the rice industry is Pr/15.
If the relative price of computers to rice were smaller than 2:3, we would have
p
p
p
N
c
N
<
2 10
=
3 15
r
N
c
10
p
<
N
r
15
That is, revenue in the computer industry would be less than in the rice industry. As a
consequence, there would not be any computer production.
2
If the relative price of computers to rice were higher than 2:3, we would have
p
p
p
N
c
N
>
2 10
=
3 15
r
N
c
10
p
>
N
r
15
That is, revenue in the computer industry would be higher than in the rice industry. As
a consequence, there would not be any rice production.
•
2b)
This ”knife-edge” behavior follows from the fact that the production possibility frontier is a
straight line in this case.
In the H-O model, the production possibility frontier is bowed out, which allows a whole
range of price ratios to be consistent with the production of both goods.
Production possiblity frontiersRicardian Model
rice
rice
Country North
Country South
40
30
60 computers
15
computers
4
Production possiblity frontiers
Heckscher-Ohlin Model
We know that North will have a comparative advantage in the x-axis good whenever the slope of the PPF
is less steep compared with South.
In the Ricardian model the PPF is less steep all the way, so North will always have a comparative
advantage independent of how much is produced.
In the H-O model the slope of the PPF depends on the production mix of the two goods.
5
North will have a coparative advatage in Cars production until the point PN. Beond this point
it is more expensive for North to produce Cars than South.
•
2c)
Same intuition as 2a)  The autarkic price of computers to rice must be 2:1.
If both goods are going to be produced:
2/3 < pc/pR < 2
Why?
If pc/pR < 2/3 <2, both countries specialize in rice
If pc/pR >2 >2/3, both countries specialize in computers
If 2/3 < pc/pR < 2 North specializes in computers and South in rice
•
3) The price ratio 1:1 means that computers will be produced in N, and rice in S. Only labour is a factor of
production, so that all revenues are paid to workers.
This means that the wage rate will equal revenue per worker.
wN = $100/10=$10
wS = $100/20=$5
•
4a)
An increase in the relative price of cars will cause labor and capital to leave the textile sector
and go to the car sector.
Since cap production is more capital intensive than textile production, the ratio of labor to
capital released by the textile industry will be higher than that demanded by the car industry.
In order for the car industry to absorb labor and capital in this proportion, the ratio of wages
to capital income will need to fall.
Damand and supply for capital and labour
r
w
Supply capital
Supply labour
↑
↓
K
L
9
•
4b)
If the ratio of capital to wage income goes up, then the capital-intensive industry will be
worse off than the labour-intensive industry. In this case, the car industry will be worse off.
•
4c)
The initial change that makes car production more profitable than textile production (the
increase in relatice price) endogenously changes factor prices so that textile production will
remain profitable.
•
6a)
For a given level of production of bread and wine, each firm has a constant returns to scale tecnology
available. There is only one input, labor, which means that the PPF is a straight line.
•
6b)
In the economy as a whole, shifting one unit of labour from wine production to bread production reduces
wine production for two reasons: there are less workers producing wine, and those who remain are less
productive.
In addition, as bread production increases, each additional worker becomes more and more productive.
This means that shifting one worker from wine to bread when all resources are in wine will increase bread
production by less than a similar shift when most resources are in bread production.
•
6c)
Both countries consume goods in fixed proportions, which means that with no trade,
production will be in an internal point on the PPF.
Under trade, a price level that exchanges B units of wine for A units of bread will allow both
countries to reach a higher indifference curve.
There are two equilibria of this kind: one for each sprcialization pattern.
The situation at which each country remains the same as in autrky is also an equilibrium, as
no country has any axcess production that it is willing to trade.
If production deviates from this point, it creates an incentive for the other country to change
production in the other direction.
In this sence, it is an unstable equilibrium