Question

Argentina	Chile
Capital	200 machines	100 machines
Labor	500 workers	400 workers

(a) Given the table above, which country is relatively more labor abundant?

Which is relatively capital abundant?

Show how you know by stating your decision rule.
(b) Suppose that the Argentina and Chile have the factor endowments given in the table in part (a).

Suppose further that the production requirements for a unit of steel is two machines and eight workers, and the requirement for a unit of wheat is one machine and eight workers.

i.Which good, wheat or steel, is relatively intensive in the use of capital?

In labor?

Show how you know by stating your decision rule.

ii.Which country would export wheat? Why?

Make sure you refer to the appropriate model/theorem in your explanation.

(c) Suppose that before trade takes place, the Argentina is at a point on its PPC where it produces 40 wheat and 40 steel.

Once trade becomes possible, the price of a unit of steel is two units of wheat.

In response, the Argentina moves along its PPC to a new point where it is producing 60 steel and 20 wheat.

Is the country better off? How do you know?

To explain your answer:

i.) draw a graph labeling both the production and consumption points before and with trade opening AND any other appropriate point /curve using the information in this part of the question,

ii.) give a simple example of trade that can take place that provides evidence to your conclusion about the effects of trade.

Make sure to mark all appropriate points/lines/axes on your graph.

(d) Given the information in part (a)-(c), explain what happens to the returns to capital and labor in each country after trade begins.Which theorem/model did you use?

Answer 1

Part A

Here we need to calculate the capital-labor ratio. The ratio 2/5 in Argentina and ¼ in Chile. So the 2/5 is higher than ¼. So Argentina is the abundant capital country, and Chile is the labor abundant country.

Part B

In this case, the capital-labor ratio to make steel is ¼ and make wheat is 1/8. So steel is more capital intensive, and wheat is more labor intensive.

Part C

Since Argentina is the capital intensive country and Chile is a labor intensive country. According to the Heckscher-Ohlin theory of trade, capital intensive country produce and export and capital intensive goods and labor intensive country produce and export labor intensive goods. So here, wheat is produced and export by Chile.

Part D

Here Argentina is better off because they consume both of the goods. If the country has traded, then they get 10 steel for 20 wheat then it would have 40 wheat for 50 steel. This is the same amount of wheat before the trade, and 10 more units of steel. So, keep 10 bread or trade some of them or trade all for getting wheat. So the consumption bundle is greater than before the trade.

In the diagram, point A shows that the production and consumption of before trade, and point B is the production of with trade and point C is the consumption of after trade.

Part E

The return to capital is different in both countries. In Argentina demand for capital increases because they produce more steel. On the same way, demand for labor falls when they produce less wheat. The owners for capital gets more benefits, and labours get fewer wages. It opposite in Chile.