ECON 433: Advanced International Trade: Theory and PolicyInstructor: Konstantin StyrinProblem set 2due 27 March 2014 in classI. Movement of labor and capital between countries1. In the short-run specic-factors model, consider a decrease in the stock of land. Forexample, suppose a natural disaster decreases the quantity of arable land used for plantingcrops.a. Redraw panel (a) of Figure 5-11 starting from the initial equilibrium at point A.b. What is the eect of this change in land on the quantity of labor in each industry andon the equilibrium wage?c. What is the eect on the rental on land and the rental on capital?d. Now suppose that the international community wants to help the country struck by thenatural disaster and decides to do so by increasing its level of FDI. So the rest of the worldincreases its investment in physical capital in the stricken country. Illustrate the eect of thispolicy on the equilibrium wage and rentals.2. Suppose that computers use 2 units of capital for each worker, so that KC = 2 · LC ,whereas shoes use 0.5 units of capital for each worker, so that KS = 0.5 · LS . There are 100workers and 100 units of capital in the economy.a. Solve for the amount of labor and capital used in each industry. Hint: The box diagramshown in Figure 5-7 means that the amount of labor and capital used in each industry mustadd up to the total for the economy, so that:KC + KS = 100,and LC + LS = 100Use the facts that KC = 2 · LC and KS = 0.5 · LS to rewrite these equations as:2 · LC + 0.5 · LS = 100,and LC + LS = 100Use these two equations to solve for LC and LS , and then calculate the amount of capital usedin each industry using KC = 2 · LC and KS = 0.5 · LS .b. Suppose that the number of workers increases to 125 due to immigration, keeping totalcapital xed at 100. Again solve for the amount of labor and capital used in each industry.Hint: Redo the calculations from part a, but using LC + LS = 125.c. Suppose instead that the amount of capital increases to 125 due to FDI, keeping the totalnumber of workers xed at 100. Again solve for the amount of labor and capital used in eachindustry. Hint: Redo the calculations from part (a), using KC + KS = 125.d. Explain how your results in parts (b) and (c) are related to the Rybczynski theorem.3. A housekeeper from the Philippines is contemplating immigrating to Singapore in searchof higher wages. Suppose that the housekeeper earns approximately $2,000 annually and expects to nd a job in Singapore worth approximately $5,000 annually for a period of 3 years.Furthermore, assume that the cost of living in Singapore is $500 more per year than at home.1a. What can we say about the productivity of housekeepers in Singapore versus the Philippines? Explain.b. What is the total gain to the housekeeper from migrating?c. Is there a corresponding gain for the employer in Singapore? Explain.II. Increasing Returns to Scale and Monopolistic Competition4. Starting from the long-run trade equilibrium in the monopolistic competition model,as illustrated in Figure 6-7, consider what happens when industry demand, D, increases. Forinstance, suppose that this is the market for cars and lower gasoline prices generate higherdemand D.a. Redraw Figure 6-7 for the Home market and show the shift in the D/N T curve and thenew short-run equilibrium.b. From the new short-run equilibrium, is there exit or entry of rms, and why?c. Describe where the new long-run equilibrium occurs, and explain what has happened tothe number of rms and the prices they charge.5. Our derivation of the gravity equation from the monopolistic competition model used thefollowing logic:(i) Each country produces many products;(ii) Each country demands all of the products that every other country produces;(iii) Thus, large countries demand more imports from other countries.The gravity equation relationship does not hold in the Heckscher-Ohlin model. Explain howthe logic of the gravity equation breaks down in the Heckscher-Ohlin model: that is, which ofthe above statements is no longer true in the Heckscher- Ohlin model?6. The United States, France, and Italy are among the world’s largest producers. To answerthe following questions, assume that their markets are monopolistically competitive, and usethe gravity equation with B = 93 and n = 1.25.FranceItalyUnited StatesGDP in 2009 ($bn)$ 2,6352,09014,270Distance from the United States (miles)5,5446,229a. Using the gravity equation, compare the expected level of trade between the United Statesand France and between the United States and Italy.b. The distance between Paris and Rome is 694 miles. Would you expect more French tradewith Italy or with the United States? Explain what variable (i. e. , country size or distance)drives your result.III. Oshoring of goods and services7. Consider an oshoring model in which Home’s high-skilled labor has a higher relativewage than Foreign’s high-skilled labor and in which the costs of capital and trade are uniformacross production activities.2a. Will Home’s oshored production activities be high or low on the value chain for agiven product? That is, will Home oshore activities that are high-skilled labor- intensive orlow-skilled-labor-intensive? Explain.b. Suppose that Home uniformly increases its tari level, eectively increasing the cost ofimporting all goods and services from abroad. How does this aect the slicing of the valuechain?c. Draw relative labor supply and demand diagrams for Home and Foreign showing theeect of this change. What happens to the relative wage in each country?8. Consider a U.S. rm’s production of automobiles, including R&D and component production.a. Starting from a no-trade equilibrium in a PPF diagram, illustrate the gains from oshoringif the United States has comparative advantage in component production.b. Now suppose that advances in engineering abroad decrease the relative price of researchand development. Illustrate this change on your diagram and state the implications for production in the United States.c. Does the U. S. rm gain from advances in research and development abroad? Explainwhy or why not.9. Consider the model of a rm that produces nal goods using R&D and components asinputs, with cost data as follows:Components:R&D:Total costs of production = PC · QC = 100Earnings of high-skilled labor = WH · HC = 25Earnings of low-skilled labor = WL · LC = 25Earnings of capital = R · KC = 50Share of total costs paid to high-skilled labor = 25/100 = 25%Share of total costs paid to low-skilled labor = 25/100 = 25%Total costs of R&D = PR · QR = 100Earnings of high-skilled labor = WH · HR = 30Earnings of low-skilled labor = WL · LR = 20Earnings of capital = R · KR = 50Share of total costs paid to high-skilled labor = 30/100 = 30%Share of total costs paid to low-skilled labor = 20/100 = 20%a. Which factor(s) is components intensive? Which factor(s) is research intensive?b. Suppose that due to the opening of trade, the relative price of R&D increases, ∆PR /PR =10%, whereas the price of components stays unchanged, ∆PC /PC = 0. Calculate the change inthe relative wage of high-skilled and low-skilled labor.c. What has happened to the relative wage of high-skilled/low-skilled labor?10. Why might it be relatively easier for an undeveloped country like India to export serviceactivities through oshoring than to participate in the global economy by producing manufacturing components?3