1. The Heckscher Olin model emphasizes as the source of comparative advantage.

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1 Study Questions for Week 3 1. The Heckscher Olin model emphasizes as the source of comparative advantage. 2. Examine table 3.2. According to the data in this table, who would have a comparative advantage in exporting goods that are capital intensive? 3. Before trade the US has abundant land (low land prices) and scarce labor (high wages). The ROW has abundant labor (low wages) and scarce land. Wheat production in land intensive and clothing production is labor intensive. So, before trade wheat prices are low in the US and high in the ROW and clothing prices are high in the US and low in the ROW. Before Trade US ROW Labor scarce abundant Wages high low Land abundant scarce Land prices low high Wheat production Land intensive Land intensive Wheat prices low high Clothing production Labor intensive Labor intensive Clothing prices high low As trade opens between the US and ROW, the US will export and import. The ROW will export and import.

2 Complete the tables below to map out the results of trade opening on markets.. US P 0 S or D Shifts Price Change Quantity Change (Domestic Q supplied) Wheat low Increase in D P wheat up Q wheat up Cloth Q cloth down Labor high Decrease in D. Q of cloth down and large number of cloth workers are laid off. (Cloth is labor intensive). Q of wheat is up, but this doesn t absorb many workers Land ROW P 0 S or D Shifts Price Change Quantity Change (Domestic Q Supplied) Wheat Cloth low Increase in D P cloth up Q cloth up Labor low Increase in D. Q of cloth up and large number of cloth workers are demanded. (Cloth is labor intensive). Q of wheat is down, but this doesn t result in many lost jobs Land World Wheat Quantity Change (world production) Cloth

3 After all the market adjustments have taken place: The price of labor will be the same in the US cloth industry as it is in the US wheat industry and these will be the same as the price of labor in ROW s wheat and cloth industries. The price of wheat will be the same in both the US and the ROW, and the price of cloth will be the same in both the US and the ROW. Now compare the pre trade and post trade quantities: US The quantity of wheat produced will be The quantity of cloth produced will be The quantity of labor employed in the wheat sector will be The quantity of labor employed in the cloth sector will be The total quantity of labor employed will be The quantity of land employed in the wheat sector will be The quantity of land employed in the cloth sector will be ROW The quantity of wheat produced will be The quantity of cloth produced will be The quantity of labor employed in the wheat sector will be The quantity of labor employed in the cloth sector will be The total quantity of labor employed will be The quantity of land employed in the wheat sector will be The quantity of land employed in the cloth sector will be The World (US+ROW) The quantity of wheat produced will be (higher/lower) (higher/lower) (higher/lower) The quantity of cloth produced will be Who wins and who loses? In the US Workers will be better off/worse off Land owners will be In the ROW Workers will be better off/worse off Land owners will be

4 5. Consider two countries; A and B. Country A has abundant skilled labor and scarce unskilled labor. Country B has abundant unskilled labor and scarce skilled labor. Will opening up trade based on comparative advantages increase wage inequality in country A? country B? Explain 6. Explain the Leontief Paradox. Use the table below to describe Leontief s findings. How might this seeming paradox be explained? 7. Are the data presented in the table below consistent with the HO theory? 8. What are economies of scale? Firms that serve world markets can increase the quantity they produce. If there are economies of scale this can lead to a in average costs. 9. What is the home market effect. What does this imply for Linder s overlapping demands theory? 10. With HO, we usually think of developed countries with high waged, skilled workers exporting their products to low wage developing countries that have abundant unskilled labor. However, most of US trade involves Canada, Japan, and the EU; countries with similar endowments of skilled labor. Use Linder s overlapping demand theory to try to explain this.

5 11. The table above shows a monopolistic competitor operating in its home market. This firm has economies of scale (note the average cost declines as Q increases). The competition part means that there are enough other firms producing similar products that price is equal to average costs so there are not excess profits. Think of the world market for compact cars (e.g Honda Civics, Toyota Corollas, Ford Focus) There is enough similarity in these products that competition drives price down to P=AC=1.9. If this market opens up to world competition, two things will happen. The firm will have access to foreign consumers. This increases their demand curve. And they will face more competition. This will make the demand curve more elastic. This is shown in the next graph. In this model, the result of opening up trade is that Price Quantity Average Cost Consumer Choice

6 12. What is intraindustry trade? Is world trade in oil a good example of intraindustry trade? Examine the table below. What types of industries are characterized by intraindustry trade? 13. According to the article on US wage inequality, the effect of US international trade has been 1. to cause the wages of both skilled and unskilled US workers to fall 2. to cause the wages of both skilled and unskilled US workers to fall 3. to lower the price of the goods purchased by low income workers and thus increase their real wages 4. ambiguous