Question

True/False-Explain. Respond to the following statements by explaining why they are true or false. For each statement, a complete and correct explanation is worth 10 points. No partial credit will be awarded for stating TRUE or FALSE without explanation.

1. [10 pts] True or False, The gravity model is a perfect fit to data on international trade flows.

2. [10 pts] True or False, In the specific factors model, wages are equal across countries but can vary across industries.

3. [10 pts] True or False, The gravity model does not fit the data on exports of goods perfectly, therefore it is a useless model. 4. [10 pts] True or False, In the Specific Factors model, wages are equal across sectors.

5. This question is about the Ricardian model with constant returns to scale and changes to the terms of trade. The economy consists of two countries; Argentina and Brazil. Each country can produce two goods, beef and soy beans. Production functions are constant returns to scale in labor. Unit labor requirements are given by, a ARG s = 2, aARG b = 1 a BRA s = 1, aBRA b = 2 The labor forces in each country, L ARG = 100, LBRA = 100 a. [15 pts] Put Ps/Pb on the vertical axis and Qs/Qb on the horizontal axis. Label your plot clearly. b. [15 pts] Let the relative global demand curve be given by, 1 Qs Qb = Ps Pb What is the equilibrium relative price of manufactured goods to agricultural goods? How much labor is allocated to each sector and how much of each good does each country produce? c. [15 pts] Suppose tofu demand increases in the United States causing the relative demand curve to shift. 1 2 Qs Qb = Ps Pb Repeat part b. with this new demand curve. d. [10 pts] Who are the winners and who are the losers as a result of this shift in the demand curve? Explain your answer using a terms of trade argument.

6. This question is about the Ricardian model with increasing returns to scale The world consists of two countries, Home and Foreign, and each is able to produce two goods. A constant returns to scale good, good 1. The unit labor requirement is constant and given by, a1 = a ∗ 1 = 1 625 An increasing returns to scale good, good 2. The unit labor requirement of good 2 falls as the labor used to produce the good rises. Specifically, a2 = h(L2) = 1 (L2) 2 a ∗ 2 = h(L ∗ 2 ) = 1 (L ∗ 2 ) 2 Finally, the labor force of each country is given by, L = 36, L∗ = 36 a. [10 pts] Find the labor allocated to each sector such that the unit labor requirement is equal across sectors. In addition, how much of each good does each country produce? b. [10 pts] Now suppose the firm that produces good two wants to concentrate production in the home country. Assume the firm wants to keep the global level of production the same as it was in autarky. What is the unit labor requiremet for good two in the home country after this change? c. [5 pts] When production of good two is concentrated in the home country the unit labor requirement falls. In order to achieve this efficiency gain, does it matter that production was concentrated in home and not foreign? Explain your answer.

7. [20 pts] Short Essay, this question is about the paper we discussed in class, The China Shock: Learning from Labor-Market Adjustment to Large Changes in Trade, by Autor, Dorn, and Hanson. The following equation is a simplified version of the regression that the authors ran, ∆ Ljτ = ατ + β1 ∆ IPjτ + jτ Where, • ∆ Ljτ , Change in labor employed in industry j over time period τ • ∆ IPjτ , Change in import penetration in industry j over time period τ • jτ , The error term What were the results of this regression? In particular, what was the sign of β1, and what is the intuition for this result?

8. This question is about the specific factors model. Consider a small open economy model of Scranton Pennsylvania. Scranton can produce two goods, paper products (p) and beets (b), and sell them on the world market. The production functions and labor resource constraints are given by, Scranton, qb(T, Lb) = T L 1 2 b , qp(K, Lp) = A K L 1 2 p Lb + Lp = 100 A > 0 is simply a productivity parameter. The capital and land endowment are given by, K = 100, T = 100 a. [10 pts] Suppose world prices are given by, Pb = 1, Pp = 1 and A = 1. How much of each good does the country produce? b. [10 pts] Now suppose that Dwight improves the paper production process leading to an increase in efficiency. In particular, A = 2. How much labor is allocated to each sector?

Answer 1

1).

The “Gravity Model of International Trade” predicts that the trade volume between two countries is directly related to the size of their GDP and inversely related to the geographical distance between them. Now, the empirically the model fitted very good and shows a strong correlation in the volume of trade between two member countries, => the given statement is TRUE.

2).

Now, in “Specific Factor Model” of international Trade “labor” is the only common input used in both the sector, => if labor will get higher wage in one sector then there will a perfect specialization in the production which is not possible here, => the wage rate in both the sector must be same, => the given statement is FALSE.

3).

As we saw that the “gravity Model” of international trade fitted the data well and is able to predict strongly the volume of trade, => the given statement is “FALSE”.

4).

As we saw that the wage of labor must be sane across sector otherwise there will full specialization in production, => the correct answer is “TRUE”.