Problem Set #2 Problem Set Instructions 1 You MUST complete your problem set on this template 2 Your answers to the multiple choice questions MUST be computer highlighted 3 Explanations MUST be...

Problem Set #2

Problem Set Instructions
1 You MUST complete your problem set on this template
2 Your answers to the multiple choice questions MUST be computer highlighted
3 Explanations MUST be word-processed Your explanations should be succinct and to the point
4 Graphs and equations MAY be drawn by hand When drawing diagrams, clearly and accurately label all
axis, lines, curves, and equilibrium points
5 You MUST staple your problem set in the upper left hand corner
Problem Set #2 (Spring 2015) 2/10
A Multiple Choice Questions (15 points) Circle the letter corresponding to the best answer (3 points each)
1 Suppose that the unit labor requirements for Home are 10 for cloth and 20 for widgets while the unit labor requirements for Foreign are 60 for cloth and 30 for widgets If the world equilibrium price of widgets were 4 cloth, then Home should:
a Export widgets and import cloth
b Export cloth and import widgets
c Export cloth and import nothing
d Export widgets and import nothing
2 Suppose that the unit labor requirements for Home are 10 for cloth and 20 for widgets while the unit labor
requirements for Foreign are 60 for cloth and 30 for widgets If wages were to double in Home, then Home
should:
a Export widgets and import cloth
b Export cloth and import widgets
c Export cloth and import nothing
d Export widgets and import nothing
3 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:
a US labor productivity equaled 40 units per hour and Japan’s 15 units per hour
b US labor productivity equaled 30 units per hour and Japan’s 20 units per hour
c US labor productivity equaled 20 units per hour and Japan’s 30 units per hour
d US labor productivity equaled 15 units per hour and Japan’s 25 units per hour
e US labor productivity equaled 15 units per hour and Japan’s 40 units per hour
4 The United States’ comparative advantage over Japan in the production of rock-n-roll music implies that
(for a similar quality of music):
a The opportunity cost of production is less in Japan
b The absolute cost of production is less in the United States
c The absolute cost of production is less in Japan
d The opportunity cost of production is less in the United States
e None of the above
5 Certain kinds of tropical fruits are impossible to grow outdoors in the United States Suppose, however, that
in order to create jobs in Wyoming, the US government offered extensive subsidies to firms to produce
bananas With the subsidies, firms could build greenhouses and offer the fruit at world prices
a The United States now has a comparative advantage in bananas
b The United States has a comparative advantage, but is not competitive
c The United States is competitive, but does not have a comparative advantage
d The United States has a comparative advantage and is competitive
e None of the above
B Analytical Question (35 points) Answer the following question based on the standard models of analysis developed in class The information in the various
parts of the question is sequential and cumulative
1 The Classic Ricardian Model Germany and Luxembourg are neighboring countries in Europe Germany has one of the largest economies in the world
while Luxembourg has one of the smallest Germany’s comparative advantage is in the production of machinery while Luxembourg’s comparative
advantage is in the production of cheese
a Use a classic Ricardian model diagram with country indifference curves for each country to clearly and accurately show each country’s
autarky production and consumption choices and use a relative supply and relative demand diagram to clearly and accurately show their
relative autarky prices for machinery These diagrams should be drawn in BLACK
b Provide an economic explanation of what you have shown in your diagrams above
c Now suppose that Germany and Luxembourg initiate free international trade However, because
Germany’s economy is very large, the relative price of machinery in Germany changes by 5% while
the relative price of machinery in Luxembourg changes by 25% Use a world relative supply and
world relative demand diagram to clearly and accurately show the equilibrium world relative price
of machinery This diagram should be drawn in BLACK
d Provide an economic explanation of what you have shown in your diagram above
e Now, on your diagrams in part a, clearly and accurately show (1) how each country’s relative prices
change, (2) how each country’s production and consumption choices change, and (3) how each
country’s economic welfare changes These changes should be drawn in RED
f Provide an economic explanation of what you have shown in your diagrams in part a Discuss (1)
how each country’s relative prices change, (2) how each country’s production and consumption
choices change, and (3) how each country’s economic welfare changes Be sure to explain why this
takes placeg What conclusions can you draw about the benefits of trade between very large economies and very
small economies?