Old Exam

Question 1

Explain intuitively why the model of Ricardo-Viner is referred to as a short-run model as
opposed to the HOS model.

Answer 1

Ricardo - Viner : immobile factors w.r.t. specific sectors => holds rather in the short run (eg capital bound in specific machine, labour trained to work on specific task)

HOS Model : Intersectorial mobility of production factors => long term consideratoins (eg sell a machine and buy / invest in a new one, retraining of labour)

Question 2

Explain the concept of dynamic increasing returns. Use an appropriate diagram to show
how dynamic increasing returns can affect international trade.

Answer 2

Companies are incenticised to produce as much as you can in economies of scale because production costs decrease when you produce more

(Notes on graph on next slide)

Question 3

How could this possibly affect international trade?

Answer 3

with producing and producing over time costs get to C1 which might affect another country like Bangladesh
- External economies of scale (cumulative output overtime)
- AC decrease as cumulative output decreases over time (=> learning curve)
- Can lack in initial advantage for a country (possible entry barrier for potentially more efficient countries due to ‘head start’ )
- Accumulation of knowledge (experience) as a potential source

Question 4

Use the Harrod-Johnson diagram to explain the effects of international trade on relative
prices, capital intensities and relative factor prices. If necessary, make appropriate assumptions. Relate your answer to the theorem of Heckscher and Ohlin.

Answer 4

Assumptions:
- The domestic country is well-endowed with capital and foreign labour
- Sector 1 is relatively capital intensive and Sector 2 is relatively labour intensive
- negative relationship between relative price of goods P1 / P2 and relative factor price w / r
(P1 / P2 increases => w/ r decreases

Effects of Trade :
- Convergence of relative prices (arbitrage argument)
- Domestic : Production (consumption of good 1 more attractive
-> export of access supply of good 1
-> Partial specialisation at good , where country enjoys comparative advantage
- Foreign : opposite to domestic
- Trade equilibrium : identical relative prices , equalization of factor prices and adjustment of sectorial capital intensities
Theorem HOS : A country exports goods , which are relatively intensively the production factors

Question 5

India and the United Kingdom have identical technologies for the production of semiconductors (S) and clothes (C). S is produced by the factors capital (𝐾𝑆) and high-qualified labor (𝐿𝐻). For the production of C, the factors capital (𝐾𝐶) and low-qualified labor (𝐿𝐿) are required. Assume that 𝐾𝑆 + 𝐾𝐶 = 𝐾. Factor substitution between capital and high-qualified labor as well as between capital and low-qualified labor is possible. Factors are immobile between countries.
Consider the following production functions:
𝑦𝑆 = 𝑓𝑆(𝐾𝑆, 𝐿𝐻) = 𝐿𝐻 𝑙𝑛(𝐾𝑆 + 1), 𝑦𝐶 = 𝑓𝐶(𝐾𝐶, 𝐿𝐿) = 𝐿𝐿𝑙𝑛(𝐾𝐶 + 1).
Both countries are endowed with the same quantity of capital and high-qualified labor, though India is endowed with more low-qualified labor. Initially, both countries did not trade with each other.

Answer 5

This is the Ricado - Viner approach because of - sector mobility and 3 production factors
- India has a comparative advantage w.r.t production of clothes
- UK has a comparative advantage w.r.t production of semi conductors

Question 6

Derive the marginal productivities of capital and explain their meaning. Illustrate the value
of the marginal product of capital for both sectors with an appropriate diagram

Answer 6

On emails in Old exam Problem 2 a)

Question 7

How does the relative supply of S and C in India compare to the UK under autarky? Use
the diagram from a) to explain.

Answer 7

in emails on old exam problem 2 b)

Question 8

What is the effect of trade between India and the UK on the relative price, production levels,
the rental rate of capital and aggregate consumption in India? Illustrate these changes with
appropriate diagrams. Show the resulting trade volume. Discuss the impact on real income
for high-qualified labor, low-qualified labor and capital owners in India.

Answer 8

in emails on old exam problem 2 c)

Question 9

The terms of trade effect and strategic trade policy are two arguments that justify the existence
of trade policy. Explain and evaluate these arguments. Discuss the role of the WTO in this
context

Answer 9

TOT effect :
- Trade policy (eg tarriffs / import restrictions ) by a large country
- Decrease of the relative world market price (of the import good)
- if strong enough , this can be welfare improvising (overcompensates production and consumption distortion)

Strategic Trade Policy :
- Means that we’re talking about imperfect competitive industries not equal to perfect competition (eg government subsidy of exports can shift market power rents to domestic firms)

Problem :
- Collective dilemma ( both / all countries may have incentives to do so) => waste of resources and worse overall outcome

Role of the WTO :
- International treaties (eg under the WTO umberella) or a delegation of decision power to supranational institutions
- self - restriction to avoid collective dilemma (that we have due to both countries having the same incentives)
- But enforcement over sovereign states..?