6 essays: Pick 3 essays

2,4,7

5. Whenever foreign direct investment occurs between industrial countries, it is referred

to as:
a. Answer egalitarian FDI.
b. balanced FDI.
c. horizontal FDI.
d. vertical FDI.
6. Which of the following is an example of horizontal FDI?
a. China invests $10 billion in Somalia.
UK
b. German investors buy the Chicago Cubs baseball team.

H
c. Sri Lanka invests $10 billion in Bangladesh.

AN
d. Bulgaria buys a golf course in Nigeria.
7. Which of the following statements refer to a vertical FDI?
a. An American company purchases a British soccer team.

General Motors
c. GM opens a plant in India.
TH
b. Ford Motor company establishes a plant in Canada.

d. BMW opens a plant in Bilbao, Spain.

CHAPTER 2. TRADE AND TECHNOLOGY:
C

THE RICARDIAN MODEL

U

Ricardian Model
D

+ Two goods: Wheat and Cloth

+ Model of one factor of production: Labor
AN

Reasons for Trade:

- Technological differences
- Differences in amounts of resources
TR

- Differences in costs of outsourcing

1 labor: 5 áo
- The proximity of countries to each other 2 labors: 9 áo
close
∆𝑄
Marginal Product of Labor: 𝑀𝑃𝐿 = ∆𝐿
=> MPL = (9-5)/(2-1) = 4 áo
Px: $1
In this situation, assume MPL is fixed. MPL: 4 áo
Lương tính bằng tiền Nominal wage = MPL x Px = 4 x $1 = $4
𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝑤𝑎𝑔𝑒 = 𝑊𝑥 = 𝑀𝑃𝐿𝑥 × 𝑃𝑥 Real wage = Nominal wage / P = $4/$2 = 2 dĩa cơm
Lương thực tế (sức mua)
𝑊𝑥 𝑀𝑃𝐿𝑥 ×𝑃𝑥 𝑃𝑥
𝑅𝑒𝑎𝑙 𝑤𝑎𝑔𝑒 = 𝑃
= 𝑃
= 𝑃
𝑀𝑃𝐿𝑥

P: average price level or price of a certain product.

dĩa cơm = $2
 Wage Parity: Under the perfect competition, the economy is stable when wages in
different industries of a country are equal. Otherwise, there are continuous movements of
labor.
Nominal wage (C) > Nominal wage (W)
Pc x MPLc >Pw x MPLw => Move to Cloth Industry
Pc x MPLc <Pw x MPLw => Move to Wheat Industry
Due to the Wage Parity: Pc x MPLc =Pw x MPLw
Pc/Pw=MPLw/MPLc Nominal wage (C) = Nominal wage (W)

𝑅𝑒𝑙𝑎𝑡𝑖𝑣𝑒 𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝐴 = 𝑃(𝐴)/𝑃(𝐵)

H
Examples: Wheat and Cloth
+ Absolute Price: Pw=$2; Pc=$4

AN
+ Relative Price of Wheat: Pw/Pc=2/4 =½ Cloth

+ Relative Price of Cloth: Pc/Pw=4/2=2 Wheat

Examples:
Home country: TH
+ One worker can produce 4W or 2C per hour: MPLw =4; MPLc=2
+ Total number of worker: L = 25
Foreign country:
C
+ One worker can produce 1W or 1C per hour: MPL*w =1; MPL*c=1
U

+ Total number of worker: L*=100

Requirements:
D

1. Write down the PPF equation of each country

Production Possibilities Frontier (PPF)
AN

G
TR

y=ax+b

x
Equation: Qc=aQw + b Qw = MPLw x L
Qc = MPLc x L
If Qw = 0 => Qc = MPLc. L = a.0 + b
G
=> b = MPLc.L (1)
If Qc = 0 => Qw =MPLw.L
H
 => 0 = a.Qw + b = a. MPLw.L + b
=> 0 = a.MPLw.L + MPLc.L
slope = a = - MPLc/MPLw (2)
From (1) and (2) we can find the PPF Equation:
Qc = a.Qw + b
𝑄𝑐 = 𝑎𝑄𝑤 + 𝑏
𝑀𝑃𝐿𝑐
𝑄𝑐 =− 𝑀𝑃𝐿𝑤
× 𝑄𝑤 + 𝑀𝑃𝐿𝑐 × 𝐿

PPF curve # budget constraint for the country

H
Answer for 1. PPF equation:
Home country: MPLw =4; MPLc=2; L=25

AN
𝑀𝑃𝐿𝑐 2
𝑄𝑐 =− 𝑀𝑃𝐿𝑤
× 𝑄𝑤 + 𝑀𝑃𝐿𝑐 × 𝐿 =− 4
× 𝑄𝑤 + 2 × 25
Qc = MPLc x Lc
𝑄𝑐 =− 0. 5𝑄𝑤 + 50 Qc =a Qw + b

Slope = a=−

Qc= -0.5Qw + 50
𝑀𝑃𝐿𝑐
𝑀𝑃𝐿𝑤
=− 0. 5
TH
Qw = 0 => Qc = b
=> b = Qc = MPLc x L = 2 x 25 = 50
Qc= 0 => 0 = a x (MPLw x L) + b
=> 0 = a x 4 x 25 + b
Qc = 0 => Qw = 100 => 0 =100a + b
Qw = 0=> Qc = -0.5 x0 + 50 = 50 => 0 = 100 a + 50
C
=> a = -50/100 = -0.5
U
D

Foreign country: MPL*w =1; MPL*c=1; L*=100

AN

𝑀𝑃𝐿*𝑐 1
𝑄𝑐 * =− 𝑀𝑃𝐿*𝑤
× 𝑄𝑤 *+ 𝑀𝑃𝐿 *𝑐 × 𝐿 *=− 1
× 𝑄𝑤 * + 1 × 100

𝑄𝑐 *=− 𝑄𝑤 *+ 100
𝑀𝑃𝐿𝑐*
TR

Slope = a*=− 𝑀𝑃𝐿𝑤*

=− 1 Q*c = aQ*w + b
 2. Identify the opportunity cost of Wheat in each country.
Opportunity Cost
Home country
MPLw = 4W => 1 công nhân có thể sản xuất ra 4W
MPLc=2C => 1 công nhân có thể sản xuất ra 2C MPLw ~ MPLc
4W - 2C
=> Để sản xuất ra được 4W họ phải từ bỏ 2C 1W - 0.5 C

1𝑊×2𝐶
=> Để sản xuất ra được 1W họ phải từ bỏ 4𝑊
= 0. 5𝐶 (𝑞𝑢𝑦 𝑡ắ𝑐 𝑡𝑎𝑚 𝑠𝑢ấ𝑡)
𝑀𝑃𝐿𝑐 MPLw - MPLc
=> The opportunity cost of 1 Wheat = 𝑀𝑃𝐿𝑤
= 0. 5𝐶 1W - ?

H
𝑀𝑃𝐿𝑤
=> The opportunity cost of 1 Cloth = 𝑀𝑃𝐿𝑐
= 2𝑊

AN
Indifference curve
+ The curve that shows different combinations of goods that bring in the
consumer the same level of satisfaction (utility)
+ Characteristics:
+ Slopes down from the left
TH
+ Each U-curve represents one level of the country’s satisfaction
C
+ To illustrate all levels of the country satisfaction, we use the
indifference map.
U

+ The higher the U-curve, the higher level of satisfaction as the country
prefers more to less.
D
AN
TR
 U1

Autarky point
(no trade)
Optiomal point

H
AN
TH
Theory of Absolute Advantage: specialise in producing and exporting the goods it has
absolute advantage (highest productivity).
So sánh MPL với món hàng nào thấp hơn thì bên đó có absolute advantage
C
cao
U

Home country Foreign country

Wheat (W) MPLw = 4 MPLw* = 1
D

Cloth (C) MPLc = 2 MPLc* = 1

MPLw>MPLw* => Home country has absolute advantage in producing Wheat
>
MPLc<MPLc*=> Home country has absolute advantage in producing Cloth
AN

Theory of Comparative Advantage: specialise in producing those goods that it produces

best compared with how well it produces other goods.
So sánh Oppo. cost với món hàng nào thấp hơn thì bên đó có comparative advantage
TR

Home country:
𝑀𝑃𝐿𝑐 2
=> The opportunity cost of 1 W = 𝑀𝑃𝐿𝑤
= 4
= 0. 5𝐶
𝑀𝑃𝐿𝑤 4
=> The opportunity cost of 1 C = 𝑀𝑃𝐿𝑐
= 2
= 2𝑊

Foreign country:
𝑀𝑃𝐿𝑐*
=> The opportunity cost of 1 W* = 𝑀𝑃𝐿𝑤*
= 𝐶*
𝑀𝑃𝐿𝑤*
=> The opportunity cost of 1 C*= 𝑀𝑃𝐿𝑐*
= 𝑊
=> Oppo.cost (W) < Oppo.cost(W*)=> Home country has comparative advantage in
producing Wheat
=> Oppo.cost (C) > Oppo.cost(C*)=> Foreign country has comparative advantage in
producing Cloth
3. Identify the pattern of trade of the two countries
The pattern of International Trade
=> TRADE WILL HAPPEN: each country has its own comparative advantage
+ Home country specialize in producing Wheat
+ Foreign country specialize in producing Cloth

H
4. Suppose the exchange rate is Pw/Pc = 2/3. Does trade happen between the two

AN
countries or not? If Yes, how much does each country benefits from trade?
Wage parity : Pw x MPLw = Pc x MPLc
The gain from trade => Pw/ Pc = MPLc /MPLw
The O.C (W) =MPLc / MPLw = 2/3 C
Xem lại examples: => 1 W = 2/3 C
Home country: TH
+ One worker can produce 4W or 2C per hour: MPLw =4; MPLc=2
+ Total number of worker: L = 25
Foreign country: Home has the comparative advantage in Wheat
C
+ One worker can produce 1W or 1C per hour: MPL*w =1; MPL*c=1
U

+ Total number of worker: L*=100 Foreign has the comparative advantage in Cloth

Relative Price of Cloth (Home) = Pc/Pw=MPLw/MPLc=4/2 = 2 4W = 2C

D

4W đổi được 2C => Home sẽ yêu thích nếu Foreign trao đổi 4W>2C=>1W>0.5C 4W > 2C
=> 1W > 0.5C
Relative Price of Cloth (Foreign) = Pc/Pw=MPLw/MPLc=1/1 =1
AN

1W = 1C
1W đổi được 1C=> Foreign sẽ yêu thích nếu Home trao đổi 1C>1W 1W < 1C
=>0.5C<1W<1C Pattern of trade

The exchange rate: Pw/Pc=2/3 (đề cho)=>W=2/3C => C = 3/2 x W

TR

0.67C
=> Thoả mãn 0.5C<1W<1C => Gain from trade

Home: 4W tự sản xuất là tốn 2C 4W = 8/3 x C

4W đi trade sẽ nhận được 4 x ⅔ x C = 8/3 C (giá trade)
Benefit = 8/3C-2C= ⅔ C per worker (Lời được ⅔ Cloth mỗi 1 công nhân)
Foreign: 1C tự sản xuất tốn 1W
1C đi trade sẽ nhận được 1x3/2xW=3/2W(giá trade)
Benefit = 3/2W - 1W= 0.5 W per worker (Lời được 0.5W mỗi 1 công nhân)
5. Graphically illustrate the benefit from trade of each country.
 Home before trade: Qc= -0.5Qw+50
Point A (Autarky point - Điểm chưa trade)
Produce at A(50W, 25C)
Qc= aQw+b
=> Qc = -0.5Qw + 50

H
AN
TH
C
Home after trade: Pw/Pc=⅔=>W=2/3C Home specializes in producing Wheat
U

Produce at B (100W;0C)=> Trade: Export 60W=> Import = 60x2/3C=40C

After trade: Consume at C(100W-60W;0C+40C)=>C(40W;40C)
D

No trade: home will produce at A (25W;50C)

Free trade: Pw/Pc=2/3 (1W=2/3C)
=> Home will produce at B (100W;0C)
AN

Home country would like

to import 40 yards of Clothes
Pw/Pc=2/3
=> 1W = 2/3 C
TR

=> C = 3/2 W
=> 40C = 3/2 x 40 x W = 60W
 Q*c = aQ*w + b
Foreign after trade: Qc*=-Qw*+100 Q*c = MPL*c x L*c
=> Q*w=0=>b
Point A* (Autarky point - Điểm chưa trade) => Q*c = 0 => a

Before trade: Produce at A* (50;50) Q*c = -Q*w + 100

Trade: Produce at B*(0W;100C)=> Export 40C => Import Wheat = 3/2x40C=60

After trade: Consume at C*(60W;60C)
+ PPF
+ Kiếm Optimal/autarky
point (no trade)
+ Indifference curve
+ World price line: Pw/Pc = 2/3
Q*c = -Q*w + 100
Q*c = 0=> Q*w = 100
Q*w=0=> Q*c = 100

H
AN
Foreign specializes in Cloth

TH
C
U

6. Assume that the price of Wheat in Home country is Pw= 2$, what should be the
price of Cloth Pc?. If the price of Cloth is Pc = 5$; Pc = 3$, what would happen?
D

Home country specializes in Wheat

Terms of trade = Pexport/Pimport Pw = Pexport
Pc = Pimport
Home country: Terms of trade = Pw/Pc foreign country specializes in Cloth
Pw/Pc = 2/3
AN

Condition to trade: 0.5C< 1W<1C $2/Pc =2/3 Pw=P*import

=> Pc= $3 Pc=P*export
The exchange rate = Pw/Pc=2/3 Pw/Pc=2/3
Terms of trade=2/3
=>The Pw=$2=> Pc=$3 to fit the exchange rate P*import/P*export = 2/3
TR

Terms of trade = P*export/P*import = 3/2

Quick Quiz:
1. Trade between two countries can benefit both countries if
a. each country exports that good in which it has a comparative advantage.
b. each country enjoys superior terms of trade.
c. each country has a more elastic demand for the imported goods.
d. each country has a more elastic supply for the supplied goods.
e. Both C and D.
2. The Ricardian theory of comparative advantage states that a country has a
comparative advantage in widgets if
 a. output per worker of widgets is higher in that country.
b. that country’s exchange rate is low.
c. wage rates in that country are high.
d. the output per worker of widgets as compared to the output of some other
product is higher in that country.
e. Both B and C.

3. A country engaging in trade according to the principles of comparative advantage

gains from trade because it

H
a. is producing exports indirectly more efficiently than it could alternatively.

AN
b. is producing imports indirectly more efficiently than it could domestically
c. is producing exports using fewer labor units.
d. is producing imports indirectly using fewer labor units.
e. None of the above. TH
4. Assume that labor is the only factor of production and that wages in the United States
equal $20 per hour while wages in Japan are $10 per hour. Production costs would be
lower in the United States as compared to Japan if
C
a. a: U.S. labor productivity equaled 40 units per hour and Japan’s 15 units per
U

hour.
b. U.S. productivity equaled 30 units per hour whereas Japan’s was 20.
D

c. U.S. labor productivity equaled 20 and Japan’s 30.

d. U.S. labor productivity equaled 15 and Japan’s 25 units per hour.
AN

e. None of the above.

5. Given the following information (in terms of unit labor requirements):
TR

a. Neither country has a comparative advantage.

b. Home has a comparative advantage in cloth.
c. Foreign has a comparative advantage in cloth.
d. Home has a comparative advantage in widgets.
e. Home has a comparative advantage in both products.
 England: Lc = 100, Lw = 120, Qc = 1,000; Qw =1,000 Qc = MPLc x Lc => MPLc = 1,000 / 100 = 10
MPLc = 10, MPLw=8.3 Qw=MPLwx Lw => MPLw = 1,000/120 = 8.3
Portugal: L*c= 80, L*w =90;Q*c =1000; Q*w = 1,000 Q*c = MPL*c x L*c => MPL*c = 1,000/80 = 12.5
MPL*c = 12.5, MPL*w=11.1 Q*w = MPL*w x L*w => MPL*w = 1,000/90 = 11.1
England Portugal MPLw<MPL*w
MPLc=10 0.83W MPL*c=12.5 1.12W MPLc<MPL*c (10<12.5)
Practice: MPLw=8.3 1.2 C MPL*w=11.1 0.88C => Portugal has absolute advantage in producing Wine
and Cloth
1. In England to produce the cloth may require the labour of 100 men for one year; and
OC (W) = MPLc/MPLw
= 10/8.3=1.2 C
if she attempted to make the wine, it might require the labour of 120 men for the same
OC(C) = 8.3/10 = 0.83W
OC(W*) =
time. . . .To produce the wine in Portugal, might require only the labour of 80 men for
one year, and to produce the cloth in the same country, might require the labour of 90
men for the same time.
a. Suppose that the amount of labor he describes can produce 1,000 yards of
cloth or 1,000 bottles of wine in either country.
b. Calculate MPL of both wine and cloth in both countries.

H
c. Which country has absolute/ comparative advantage?, explain.

AN
O.c (C)<O.c(C*) (0.83<1.12)=> England has comparative advantage in producing Cloth
O.c (W) > O.c (W*) (1.2 > 0.88) => Portugal has comparative advantage in producing ine
2.

TH
C
U
D
AN

3. Given the following information about China and the United States (in one
TR

labor-hour):

MPLc= 1 MPL*c= 1.5

MPLf= 1 MPL*f= 0.67

O.c (C) = MPLf/MPLc = 6/6=1
China has com adv in producing Cloth
US has com adv in producing Food
Using the comparative advantage:
a. Identify pattern of trade between the two countries and condition for trade
China:
Pattern of trade: Trade happens when 6C=6F=> 1C = 1F => China prefer to trade if 1C > 1F (1)
China specializes in producing Cloth US:
US specializes in producing Food 8C = 12F => US prefer to trade if 12F > 8C => 1.5F > C (2)

=> 1F < 1C < 1.5F (Pattern of trade)

d. China: US:
One labor can produce 6C or 6F in the same hour One labor produce 8C or 12F in the same hour
If trade 1C=1.2F=> C = 1.2F If trade 1C = 1.2F => F = 1/1.2 C = 0.83C, US will receive
China will export 6C = 6x1.2F = 7.2F 12 x 0.83 C = 10C
Benefit from trade = 7.2F - 6F = 1.2F per worker in the same hour Benefit from trade = 10C - 8C = 2C per worker in the same hour

b. Is there any international trade between the two countries if the exchange rate
b. China:
One labor can produce 6C is 1C =2F? 2F>1F => Not satisfy the pattern of trade => There is no international trade
or 6F in the same hour
If trade 1C=2F c. Is there any international trade between the two countries if the exchange rate
=> C = 2F => Satisfy the pattern of trade => There is international trade
China will export 6C = is 1C =1.2 F? => China export Cloth and import Food, US export Food and import Cloth
6x2F = 12F
Benefit from trade = 12F -d. If yes, identify how much each country would benefit from trade in the two
6F = 6F per worker in the Case b: Each country has no gain from trade
same hour cases (b) and (c). Case c: Each country has gain from trade
4. Suppose that a small open economy has 200 workers and that its technology requires
US:
1 worker-hour per unit of food and 3 worker-hours per unit of cloth. In autarky, it
One labor produce 8C or
12F in the same hour
employs 100 workers in each of the two industries. With free trade, it faces world

H
If trade 1C = 2F
=> F = 1/2 x C = 0.5C
prices of $10 per unit of food and $20 per unit of cloth.

AN
US will receive
12 x 0.5 C = 6C a. Suppose that in autarky, workers in both industries are paid $8 per hour. What
Loss from trade = 6C -
8C = -2C per worker in are the autarky prices of food and cloth?
the same hour
b. When the country opens to free trade, under the normal assumptions of the

TH
Ricardian model, what will it produce, import, and export? From the
information given, can you determine the quantities of any of these? What is
the country’s national income with trade, measured in dollars?
c. Suppose, contrary to the normal Ricardian Model assumptions, that when
C
trade is opened, workers are unwilling or unable to change occupations, so that
U

we continue to have 100 workers in each industry. What, then, is the national
income of the country, in dollars, and how does it compare to the national
D

income you got in part (b) when workers were mobile?

d. What are the wages of the two groups of workers in part c?
AN

e. Do you think that the country gains from trade in part (c)? Who gains and who
loses within it?
f. What has happened, as a result of trade, to the real wage of labor
TR
 CHAPTER 4. TRADE AND RESOURCES: THE
HECKSCHER-OHLIN MODEL
Model of one factor of production: Labor and Capital
+ 2 countries: Home and Foreign
+ 2 goods: Computer (C) and Shoes (S)
Home: K = Ks + Kc, L = Ls + Lc
Foreign: K*=K*s + K*c, L*=L*s + L*c
+ Both factors of K and L can move freely between the two industries in a country.

H
+ Shoe production is Labor-Intensive product: which means that to produce Shoes,

AN
the country uses many units of labor. (Ls/Ks>Lc/Kc)
+ Computers are a Capital Intensive Product: which means that to produce
Computers, a country uses many units of Capital. (Kc/Lc>Ks/Ls)

TH
+ Foreign is a Labor-abundant country. Home is the Capital abundant country.
+ Free trade of computers and shoes between the two countries. But Labor and Capital
can not move freely between the two countries.
+ Technologies used to produce the two goods are identical across the countries.
C
+ Consumer tastes are the same across countries and do not depend on the country’s
U

level of income.
+ Reverse of factor intensities: due to specific features of a particular country, a
D

capital-intensive product in one country is considered as a labor-intensive product in

another country and vice versa.
AN

+ aL: labor units require to produce 1 unit

+ aK: capital units require to produce 1 unit
Home country:
TR

𝑎𝐿𝑐 × 𝑄𝑐 + 𝑎𝐿𝑠 × 𝑄𝑠 = 𝐿
𝑎𝐾𝑐 × 𝑄𝑐 + 𝑎𝐾𝑠 × 𝑄𝑠 = 𝐾
=> Qs = L/aLs – aLc/aLs x Qc
Shoe production is labor-intensive; it requires more labor per unit of capital to produce shoes
than computers, so aLc/aLs > aKc/aKs
=> In a two factor economy, PPF is a curve, not a straight line
Value equation of production: 𝑉 = 𝑄𝑐 × 𝑃𝑐 + 𝑄𝑠 × 𝑃𝑠
=> Iso - Value Line: 𝑄𝐹 = 𝑉/𝑃𝑠 − 𝑃𝑐/𝑃𝑠 × 𝑄𝑐

V increases=> Iso Value line shift out=> makes up an Iso - Value Map.
Heckscher - Ohlin Theory
+ A labor abundant country can benefit from international trade if it specializes in
producing and exporting the Labor-Intensive Product.
Ex: Vietnam can benefit from trade if it choose to produce and export labor-intensive
products such as: shoes, cloth, etc.
+ A Capital abundant country can benefit from trade if it specializes in producing and
exporting the Capital Intensive products.
Ex: Germany produces and exports cars, drills, machines, etc.

H
Home country:

AN
TH
C
U
D

+ No trade equilibrium: Point A (Autarky point)

AN

+ Free - trade: produce at B and consume at C

+ Imports = Qs3 - Qs2
+ Export = Qc2 - Qc3
TR

+ Trade triangle = Green space

=> Home is the capital abundant country=> Export capital intensive product (C)
=> Home export supply curve (panel b)
Foreign country:
 H
AN
+ No trade equilibrium: Point A* (Autarky point)

TH
+ Free - trade: produce at B* and consume at C*
+ Imports = Qc*3 - Qc*2
+ Export = Qs*2 - Qs*3
+ Trade triangle = Green space
C
=> Foreign is the labor abundant country=>Import capital intensive product (C)
U

=> Foreign import demand curve (panel b)

D
AN
TR

- The equilibrium free trade price is determined by the intersection of the Home export
supply curve and the foreign import demand curve: Point D.
 - At that relative price, the quantity that Home wants to export equals the amount that
Foreign wants to import.
- This is a free-trade equilibrium since there is no reason for the relative price
to change.
Important outcomes:
+ (Pc/Ps)W>(Pc/Ps)A=> incentive for Home to produce and export more computers due
to the increase in the relative price of Home
+ (Pc/Ps)W<(Pc/Ps)B=> Foreign will get benefits to get low price rather than self -
produce due to the decrease in relative price of Foreign in Computers

H
Disadvantage:

AN
+ Only use in between developed (capital abundant) and developing (labor abundant)
countries
+ The H-O theory could not explain why the Unites States produces and export cars

TH
and, at the same time, imports cars from other countries (Intra-Industry Trade).
Leontief Paradox
Problem: United States, which was a capital-abundant country, has produced and
exported large amount of labor-intensive products and imported capital-intensive products.
C
Reasons:
U

- The data collected were not reliable (after WW2)

- The U.S. was not engaged in completely free trade
D

- The labor-intensive industries were highly protected by the US government. It

restricted the imports of labor-intensive products.
AN

- No distinction between skilled and unskilled labor: Leontief mainly mentioned

physical capital (machines, factories, etc.) and ignored the human capital. Adding
human capital to physical capital would make the US export more capital intensive
TR

products.
Stolper - Samuelson
The Stolper-Samuelson Theorem:
In the long run when all factors are mobile, an increase in the relative price of a good
will increase the real earnings of the factor used intensively in the production of that good
and decrease the real earnings of the other factor.
Ex: the relative price of Cloth (labor-intensive product) increases, the real labor wage
in the Cloth industry will increase and the real labor wage in the Food industry will reduce.
Therefore, in the Heckscher-Ohlin model:
 The abundant factor gains from trade, and the scarce factor loses from trade.
Quick Quiz:
1. In the 2-factor, 2 good Heckscher-Ohlin model, the two countries differ in:
A. tastes. D. relative availabilities of factors of production.
B. military capabilities. E. labor productivities.
C. size.
2. In the 2-factor, 2 good Heckscher-Ohlin model, a change from autarky (no trade) to trade
will benefit the owners of:
A. capital.

H
B. the relatively abundant factor of production.

AN
C. the relatively scarce factor of production.
D. the relatively inelastic factor of production
E. the factor of production with the largest elasticity of substitution.

TH
3. One way in which the Heckscher-Ohlin model differs from the Ricardo model of
comparative
advantage is by assuming that __________ is (are) identical in all countries.
A. factor of production endowments
C
B. scale economies
U

C. factor of production intensities

D. technology
D

E. opportunity costs
4. According to the Hecksher-Ohlin model,
AN

A. everyone automatically gains from trade

B. the scarce factor necessarily gains from trade
C. the gainers could compensate the losers and still retain gains.
TR

D. a country gains if its exports have a high value added.

E. None of the above.
5. Starting from an autarky (no-trade) situation with Heckscher-Ohlin model, if Country H is
relatively labor abundant, then once trade begins:
A. wages and rents should rise in H.
B. wages and rents should fall in H.
C. wages should rise and rents should fall in H.
D. wages should fall and rents should rise in H.
E. None of the above.
6. Suppose that there are two factors, capital and land, and that the United States is relatively
land endowed while the European Union is relatively capital-endowed. According to the
Heckscher-Ohlin model,
A. European landowners should support US-European free trade.
B. European capitalists should support US-European free trade.
C. all capitalists in both countries should support free trade.
D. all landowners should support free trade.
E. None of the above.

H
7. Assume that only two countries, A and B, exist.

AN
Consider the following data: Countries
Factor Endowments A B
Labor Force 45 20
Capital Stock 15 10 TH
If good S is capital intensive, then following the Heckscher-Ohlin Theory,
A. country A will export good S.
C
B. country B will export good S.
U

C. both countries will export good S.

D. trade will not occur between these two countries.
D

E. Insufficient information is given.

8. Wassily Leontief used an input-output table in order to test the
AN

A. Ricardian theory of comparative advantage

B. Heckscher Ohlin theory of comparative advantage
C. Linder theory of overlapping demand
TR

D. all of the above

Practice:
1. This problem uses the Heckscher–Ohlin model to predict the direction of trade.
Consider the production of handmade rugs and assembly line robots in Canada and
India given Canada's relatively small population (approximately 30 million compared
with more than 1 billion in India) and level of development between two countries.
a. Which country would you expect to be relatively labor-abundant, and which is
capital-abundant? Why?
 b. Which industry would you expect to be relatively labor-intensive, and which is
capital-intensive? Why?
c. Given your answers to (a) and (b), draw production possibilities frontiers for each
country. Assuming that consumer preferences are the same in both countries, add
indifference curves and relative price lines (without trade) to your PPF graphs. What
do the slopes of the price lines tell you about the direction of trade?
d. Allowing for trade between countries, redraw the graphs and include a “trade
triangle” for each country. Identify and label the vertical and horizontal sides of the
triangles as either imports or exports.

H
e. Using the PPF graphs from (c) and relative prices under autarky and trade, explain

AN
how both countries gain from trade?
2. Suppose when Russia opens to trade, it imports automobiles, a capital-intensive good.
a. According to H-O theorem, is Russia capital abundant or labor abundant? Briefly
explain? TH
b. What is the impact of opening trade on the real wage in Russia?
c. What is the impact of opening trade on the real rental on capital?
d. Which group (capital owner or labor) would support policies to limit free trade?
C
U
D
AN
TR
 H
AN
CHAPTER 7. IMPORT TARIFFS AND QUOTAS UNDER
PERFECT COMPETITION

TH
Trade policy = a government action meant to influence the amount of international trade
+ Import tariff = a tax on imported goods
+ Import quotas = quantity limits on imports
C
+ Export subsidies = the exporter receives higher than price than the buyer pays
U

The gain from trade: Consumer and Producer Surplus

D

lower price or higher quality

AN

Autarky point

Consumer surplus
TR

$10

Producer surplus
World price

Qo
No trade: Autarky point Free trade
CS1 = a CS2=a+b+d
PS1 = b + c PS2 = +c
HW1 = a+b+c HW2 = a+b+c+d
Import = M1 = D1 - S1

∆CS = CS2 - CS1 = a +b+d - a = +b+ d

∆PS = PS2 - PS1 = +c - b - c = -b
∆HW = HW2 - HW1
PS2 + CS2 - PS1 - CS1 = ∆PS + ∆CS=
= a+b+c+d - a- b-c = +d
No trade: Using PA
Home’s welfare (no trade) +a+b+c
Total surplus = CS + PS

Free trade for a small country:

H
AN
Gain from trade: Using Pw
TH
∆CS +b +d
C
∆PS -b
U

Net effect on Home’s welfare +d

D

Home Import Demand Curve

AN
TR
 No trade: Pa(Autarky point)=> CS, PS
Free trade: Pw (world price)=> NE = ∆CS + ∆PS
Free trade with tariff: Pw + t=> NE=∆CS +∆PS + ∆G (create DWL = - NE)
Free trade with quotas:
Effect of the tariff:
Free trade for a small country
M2=D2 - S2
M1 = D1 - S1
M1 - M2 = D1 - S1 - D2 +S2
= (D1 -D2) + (S2-S1)

H
1/2 x t x (D1-D2)+1/2 x t x (S2-S1)

AN
t t

M2 TH M2
C
=D1 - S1
M2 = Import = D2 - S2
Overall effect of tariff:
U

∆CS -(a+b+c+d)
∆PS +a
D

∆G (Government revenue) +c
t x M2
AN

∆CS +∆PS +∆G

NE of Home’s welfare -(b+d)
=> DWL (Deadweight loss) b+d
TR

Effect of quotas:
Import Quota in a small country:
 H
Decrease to M2

AN
If home country impose a quota
VN <===computers======US
VN govt impose a quota US govt impose a voluntary export
Import (VN) decrease restriction
Overall effect of quotas: => Quota rents Import (VN) decrease
∆CS
∆PS
-(a+b+c+d)
+a
TH => VN does not receive quota rents

US export computers to VN

Quota rents +c
C
NE of Home’s welfare -(b+d) < 0 NE =∆CS+∆PS +Quota rents
U

=> DWL (Deadweight loss) b+d

D

Overall effect of voluntary export restrictions:

∆CS -(a+b+c+d)
AN

∆PS +a

NE of Home’s welfare -(b+c+d) < 0

TR

=> DWL (Deadweight loss) b+c+d

Practice:
1. A small country has the demand and supply: Qd = 400 – 10P and Qs= 40+5P. The
import price is 10$/ unit.
a. Calculating the CS and PS in free trade.
b. Suppose that the government imposes a quota of 60 units.
c. What is the price and quantity of consumption and production? What is the quota rent,
production and consumption distortion? ∆PS
∆CS
Quota rents
 No trade: Pa(Autarky point)=> CS, PS
Free trade: Pw (world price)=> NE = ∆CS + ∆PS
Free trade with tariff: Pw + t=> NE=∆CS +∆PS + ∆G (create DWL = - NE)
Free trade with quotas:
+ Home impose quotas: => NE = ∆CS+∆PS +Quota rents
Qd= 400 - 10P
+ Home does not impose quotas but Foreign do it: => NE = ∆CS + ∆PS
Qs = 40 + 5P

Demand:
P S Qd = 0 => 0 =400 - 10P
=> P = $40
P=0 => Qd = 400 - 0 = 400

Supply:
$40 P = $40 => Qs = 40 + 5 x 40 = 240

P = 0=> Qs = 40 + 5 x 0 = 40
$24 Pw = $10/unit
$20
At the autarky point: Qs = Qd
$10 400 - 10P = 40 + 5P
D
Q 360 = 15P
40 90 140 ? 200240 300 400 P = $24
Free trade: Pw
Qs=40+5P Qd = 400 - 10P
Qs = 40 + 5 x 10 Qd = 400 - 10 x $10 CS1 = 1/2 x ($40 - $10) x 300 =$4,500
= 90 = 300 PS1= $10 x 40 + 1/2 x $10 x (90-40) = $650
P
Import =300 - 90 = 210
X*
IM2= Qd2 - Qs2 = 60
=> Qd2 = 60 + Qs2
Qd= 400 - 10P
$20
Qs = 40 + 5P
c 60 +Qs2 = 400 - 10P
X* 60 + 40 + 5P = 400 - 10P Qd = 400 - 10P= 400 - 10 x 20
$10
=> 15P=300 = 200
M => P = 20 Qs = 40+5P = 40 + 5x20 = 140

Import Quota rents = c = ($20 - 10) x 60 = $600

60 210
∆CS = CS2 - CS1= 1/2 (40-20)x200 - $4,500=-$2,500
∆PS= ($20-10)x90+1/2x(20-10)x(140-90)
 d. To maximize the quota rent, how much should the government impose on import?

2. You are given the following information about the market for motorcycles.
Market Demand: P = 400 – 4Q
Market Supply: P = 4Q
a. Find the equilibrium price and quantity in this market.
b. What is the value of consumer surplus in this market?
c. What is the value of producer surplus in this market?
d. Suppose that the government decides to impose an excise tax of $80 per motorcycle

H
on producers in this market. What will be the number of motorcycles sold in this

AN
market once this tax is imposed?
e. Given the tax described in part (d), what will be the tax incidence on consumers?
f. Given the tax described in part (d), what is the value of the deadweight loss from the
tax? TH
g. What is the loss in producer surplus from the imposition of the excise tax described in
part (d)?
h. Suppose the government would like motorcycle consumption to fall to 20 units.
C
Relative to the initial situation before there was any excise tax, how big an excise tax
U

would the government need to place on motorcycles in order for consumption to fall
to 20 units?
D

3. The nation of Bermuda is “small” and assumed to be unable to affect world prices. It
imports strawberries at the price of 10 dollars per box. The Domestic Supply and Domestic
AN

Demand curves for boxes are:

S = 60 + 20P
D = 1160 − 15P
TR

a. Assume Bermuda is Completely open to trade. What is the equilibrium price and
quantity consumed? How much is produced domestically, and how much is imported?
b. Now consider the effect of an import quota of 400 boxes. What happens to the price
of strawberries and quantity consumed?
c. Who wins and who loses? Discuss consumers, domestic producers, and importers (Be
sure to compute the change in their welfare).

4. Data of a perfect competition market for good X is given by the following supply and
demand equation
(D): P=-Q+1000
(S): P=1/2Q + 700
The world price: Pw = $760
Assume that the country is small and there is free trade
a. Calculate the imported amount of good X, domestic quantity supplied and quantity
demanded at the world price
b. Now the government impose a tax of t = $20/imported product. Identify the effect of
tariff on the importing country in terms of: domestic production, domestic demand,
domestic price.

H
c. Instead of using tariff, now the government uses quotas. It has issued quotas for the

AN
imported good X to restrict the imported amount down to IM1=70 imported units
only. Identify the new domestic price in the market under the effect of quotas
d. Identify changes in the economic welfare after the quota policy

TH
C
U
D
AN
TR