International Economics I

Final Exam - Sketchy Solutions

Alessandra Bonglioli
Universitat Pompeu Fabra
December 16, 2014

Mode A - Multiple Choice

If you choose this mode, the grade of this exam will account for 45% of your
nal grade
For 9 out of the following 10 questions, select the right statement and explain
why, based on the models and the empirical evidence we analyzed throughout
the course.
1. Consider a sector characterized by internal economies of scale, where homogeneous rms produce a dierentiated good and operate under monopolistic competition. An increase in the elasticity of substitution between
varieties:
(a) raises both the price of each variety and the equilibrium number of
varieties, and reduces the scale of each rm
(b) raises the price of each variety and reduces both the scale of each
rm and the equilibrium number of varieties
(c) reduces the price of each variety and raises both the scale of each
rm the equilibrium number of varieties
(d) reduces both the price of each variety and the equilibrium number
of varieties, and raises the scale of each rm (right: higher elasticity
of substitution implies that consumers become more reactive to price
changes, which reduces the monopoly power of each rm over its own
variety and hence the markup it can charge over its marginal cost and
the price (p = M C= with capturing elasticity of substitution). It
follows that demand, thus the scale of production, increases (q =
F C=(1
)M C). Since rms produce larger quantities, each of
them needs to hire more workers, which implies that fewer varieties
can be produced (n = (1
) L=F ).

2. Consider a sector characterized by internal economies of scale, where homogeneous rms produce a dierentiated good and operate under monopolistic competition. If the elasticity of substitution is higher than one (i.e.,
the case we considered in class), trade with a symmetric country that has
the same preferences, technolgy and size:
(a) doubles the number of varieties available to domestic and foreign
consumers and more than doubles their utility
(b) doubles the number of varieties available to domestic and foreign
consumers and less than doubles their utility (right: symmetric countries produce the same number of varieties, n, with the same scale,
q, and price, p. This implies that trade double the number of varieties available to consumers. Utility increases both in the number
of varieties and, to a lesser extent captured by
2 (0; 1), in the
quantity consumed of each variety. since the number of consumers
demanding each variety doubles, quantities are halved. This implies
that, although varieties double, utility increases but less than doubles: U F T =U A = 21 ).
(c) reduces by half the price of each variety and doubles the number of
varieties available to domestic and foreign consumers
(d) reduces by half the price of each variety and doubles the quantity
consumed of each variety
3. International trade in the presence of external economies of scale
(a) generates the same gains as trade under comparative advantage
(b) generates the same gains as trade under internal economies of scale
(c) makes the price of a good converge to the average of the autarky
prices of the trading partners
(d) makes the price of a good drop for all trading partners (right: external economies of scale imply that the average cost of production decreases as the scale of productions rises, at the industry level. Firms
in sectors characterized by ext. eco of scale act competitively and
charge a price equal to the average cost, which implies that the supply schedule is downward sloping. Trade liberalization makes such
that the country that is able to charge a lower price becomes the
world supplier of a certain good. This raises the scale of production
and reduces the price even below the lowest autarky price)
4. Consider a sector characterized by internal economies of scale, producing a dierentiated good which is sold under monopolistic competition.
Firms are heterogeneous with respect to their productivity, and can decide whether to carry out part of their production process (representing a
share of the variable cost) in their own country or in a foreign country,
where wages are lower but a xed investment fI is required. In this sector,
2

there will be fewer rms doing vertical FDI (i.e., partly producing in the
foreign country) if:
(a) the foreign country becomes relatively more labor abundant
(b) the foreign country becomes more e cient
(c) the share

is higher

(d) the share

is lower (right: when deciding whether to do vertical
FDI, rms face a trade-o between lower variable costs and higher
xed costs. The lower the savings in vc, and the higher the xed cost,
the less likely vertical FDI. What reduces the extent of savings is the
relative increase of wages in the foreign country and a reduction in
the share of variable costs that can be oshored, . With a lower ,
a larger scale of production is required for a rm to nd the saving
in vc high enough to compensate the xed cost of settling a plant
abroad)
5. Consider a sector where rms with heterogeneous productivity produce a
dierentiated good subject to increasing returns to scale, and sell it under
monopolistic competition. Exporting entails both a xed a variable cost,
while serving the foreign market through horizontal FDI only entails a
higher xed cost. If the variable cost of trade bilaterally increases:
(a) exporters gain foreign market shares relative to horizontal multinationals
(b) exporters lose foreign market shares relative to horizontal multinationals (right: an increase in the variable cost of trade raises the
price that exporters have to charge in the foreign market, thereby
reducing both sales and prots there. This aects exporters along
two margins: the least productive ones exit from the foreign market
and keep serving only the domestic one, and the most productive
ones nd horizontal FDI more protable than export. This reduces
both the number of rms serving the foreign market and the market
share of exporters relative to multinational abroad. A reduction in
the number of foreign rms on the market also raises protability
and hence allows more rms to survive in the domestic market.)
(c) the number of rms serving the foreign market increases
(d) the number of rms serving the foreign market is unchanged
6. Consider a sector where rms with heterogeneous productivity produce a
dierentiated good subject to increasing returns to scale, and sell it under
monopolistic competition. Firms can export to many foreign markets: on
top of the variable trade cost, entering in each foreign market entails a
xed export cost. Assuming that both the xed and the variable costs are
equal for all destinations, then:

(a) the largest rms export to all markets (right: when there are xed
and variable trade costs, rms decide to export if they are able to
sell enough so to (more than) cover the xed cost. Two factors determine the sales of a rm: is its own productivity, aecting its price
and demand, and the general protability of the market, which in
turn depends on the number of comsumers and the average price
of competitors. This implies that, all things equal, a larger market
allows any rm to sell more and earn higher prots. Hence, any sufciently productive rm wil be able to serve the largest market and
do it, while only the most productive (and largest) ones will also be
able to cover the additional xed costs entailed by serving also all
the other countries, up to the smallest one)
(b) all rms export to the smallest market
(c) only the smallest rms serve the smallest foreign market
(d) only the smallest rms serve the largest foreign market
7. An export subsidy:
(a) has the same welfare eect as an import tari
(b) has the same welfare eect as a voluntary export restriction
(c) may induce a positive terms of trade eect for the country adopting
it
(d) may induce a negative terms of trade eect for the country adopting
it (right: an export subsidy is an amount paid by the government
to rms for the goods they export. This induces a partial subtitution between domestic and foreign demand, supported by a drop in
the price charged to foreign consumers, and an increase in the price
charged to domestic consumers, i.e., a terms of trade deterioration
for the country adopting the subsidy.)
8. Consider a large country, C, importing a good from another large country,
A. The import demand and export supply functions are:
M DC : Q = 40

2P & XS A : Q = 10 + 4P:

If C applies a xed tari t = 3 on each imported unit, then:

(a) import price will incease by 3 relative to the free-trade price, import
will fall by 6 units and welfare will fall
(b) import price will increase by 3 relative to the free-trad price, import
will fall by 6 units and welfare will incease
(c) import price will increase by 2 relative to the free-trad price, import
will fall by 4 units and welfare will increase (right:
under free trade, the price satises 40 2PW = 10 + 4PW ! PW = 5,
and import is QW = 30. With the tari, export price satises
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40 2 (PT + 3) = 10 + 4PT ! PT = 4, hence import price is

PT = PT + 3 = 7 (increases by 2) and import is QT = 26 (falls
by 4). To compute the welfare eect, remember that the e ciency
loss is (QW QT ) (PT PW ) =2 = 4 while the terms of trade gain is
QT (PW PT ) = 26, which implies an overall welfare gain of 22)
(d) import price will increase by 2 relative to the free-trad price, import
will fall by 4 units and welfare will fall
9. Consider a large country, C, importing two goods, Y and Z, respectively
from A and B, both being large countries. Assuming that the import
demand and export supply schedules are:
M DYC

: PY = 100

2QY & XSYA : PY = 10 + 2QY

C
M DZ

: PZ = 100

2QZ & XSZB : PZ = 10 + 4QZ ;

(a) C should optimally apply a higher tari on good Y since XSYA is

more elastic than XSZB
(b) C should optimally apply a higher tari on good Y since XSYA is
more inelastic than XSZB
(c) C should optimally apply a higher tari on good Z since XSYA is more
elastic than XSZB (right: since the import demand schedule is the
same for both goods, how import and export prices react to the tari,
only depends on the elasticity of the export supply functions. In
this case, the supply of Z is more inelastic (1/4<1/2), which implies
that the tari will be borne its foreign producers by lowering the
export price to a larger extent than for good Y . It follows that the
government of country C will nd a tari on Z preferable)
(d) C should optimally apply the same tari on both goods since its
import demand has the same elasticity for both goods
10. A country has an interest in imposing taris:
(a) only if it is large enough to benet from a terms of trade eect
(b) if it is relatively capital abundant, given that the median voter is a
worker (right: a capital-abundant country tends to specialize in capital intensive goods, whose relative price increases under free trade,
thereby disproportionately raising the return to capital relative to
labor (Stolper-Samuelson eect). For this reason, workers would be
harmed by free trade and hence support the candidate proposing
high taris. Since workers are the majority of voters, the government of this country, irrespectively of country size, will be in favor
of imposing taris)
(c) if it is relatively labor abundant, given that the median voter is a
worker
(d) in sectors with a higher ratio between import and domestic sales
5

Mode B - Multiple Choice

If you choose this mode, the grade of this exam will account for 85% of your
nal grade
For 9 out of the following 10 questions, select the right statement and explain
why, based on the models and the empirical evidence we analyzed throughout
the course.
1. Consider a sector characterized by internal economies of scale, where homogeneous rms produce a dierentiated good and operate under monopolistic competition. If the elasticity of substitution is higher than one (i.e.,
the case we considered in class), trade with a symmetric country that has
the same preferences, technolgy and size:
(a) doubles the number of varieties available to domestic and foreign
consumers and more than doubles their utility
(b) doubles the number of varieties available to domestic and foreign
consumers and less than doubles their utility
(c) reduces by half the price of each variety and doubles the number of
varieties available to domestic and foreign consumers
(d) reduces by half the price of each variety and doubles the quantity
consumed of each variety
2. Consider a sector characterized by internal economies of scale, producing a dierentiated good which is sold under monopolistic competition.
Firms are heterogeneous with respect to their productivity, and can decide whether to carry out part of their production process (representing a
share of the variable cost) in their own country or in a foreign country,
where wages are lower but a xed investment fI is required. In this sector,
there will be fewer rms doing vertical FDI (i.e., partly producing in the
foreign country) if:
(a) the foreign country becomes relatively more labor abundant
(b) the foreign country becomes more e cient
(c) the share

is higher

(d) the share

is lower

3. International trade in the presence of external economies of scale

(a) generates the same gains as trade under comparative advantage
(b) generates the same gains as trade under internal economies of scale
(c) makes the price of a good converge to the average of the autarky
prices of the trading partners
(d) makes the price of a good drop for all trading partners
6

4. Consider a large country, C, importing two goods, Y and Z, respectively

from A and B, both being large countries. Assuming that the import
demand and export supply schedules are:
M DYC

: PY = 100

2QY & XSYA : PY = 10 + 2QY

C
M DZ

: PZ = 100

2QZ & XSZB : PZ = 10 + 4QZ ;

(a) C should optimally apply a higher tari on good Y since XSYA is

more elastic than XSZB
(b) C should optimally apply a higher tari on good Y since XSYA is
more inelastic than XSZB
(c) C should optimally apply a higher tari on good Z since XSYA is
more elastic than XSZB
(d) C should optimally apply the same tari on both goods since its
import demand has the same elasticity for both goods
5. A country has an interest in imposing taris:
(a) only if it is large enough to benet from a terms of trade eect
(b) if it is relatively capital abundant, given that the median voter is a
worker
(c) if it is relatively labor abundant, given that the median voter is a
worker
(d) in sectors with a higher ratio between import and domestic sales
6. Consider two countries, h and f , using only labor to produce N goods
with dierent technologies. Preferences are the same in both countries
and feature the same expenditure share (1=N ) in each good. Initially,
under free trade, country h produces and exports one quarter of the goods,
while f produces and exports the remaining three quarters, and the wage
of country h is equal to the wage of country f . After a while, country
h produces and exports one half of the goods and f the remaining half,
while the wage in h is three times as high as the wage in f . This is due
to:
(a) uniform technolgical progress in h (right: in the Ricardian model
described above, the only way a country can experience both an
increase in its relative wage and in the share of goods produced and
exported, is through uniform technological progress. If this happens,
country h will become the most e cient producer of more goods, due
to higher productivity. At the same time, since the relative demand
for its exports increases, its labor force will become worthier and
hence the relative wage will increase)
(b) uniform technolgical progress in f

(c) migration from a third country to h

(d) migration from a third country to f
7. Consider two countries, h and f , using only labor to produce N goods
with dierent technologies. Preferences are the same in both countries
and feature the same expenditure share (1=N ) in each good. Assume a
fraction of the goods is non tradable and country f is running a current
account decit T . Then, for given T :
(a) an increase in the fraction of non-tradable goods, , would raise the
relative wage of country h
(b) an increase in the fraction of non-tradable goods, , would reduce
the relative wage of country h (right: if the share of non-tradable
goods increases, country f allocates a larger share of the transfer
received from country h (decit) to domestically produced and consumed goods, and conversely country h will spend even less in domestic goods, which will further increase the relative demand for goods
produced by f (and its labor force) and hence its relative wage.)
(c) an increase in the fraction of non-tradable goods, , would not aect
the ralative wage
(d) an increase in the fraction of non-tradable goods, , would make the
rebalancing of the current account more painful for country h
8. In a 2-country and 2-good world with specic factors and comparative
advantege, under free trade, the owners of the factor specic to the importcompeting good:
(a) gain with respect to the imported good and lose with respect to the
exported one
(b) gain with respect to the exported good and lose with respect to the
imported one
(c) gain with respect to both goods
(d) lose with respect to both goods (right: the imported good is the
one that becomes relatively cheaper under free trade. What happens
in this framework is that specialization in the exported good drives
workers out of the import-competing sector, and wages up in both
sectors (by less than the increase in the relative price), which makes
real wages higher in terms of the imported good. The real return to
the specic factor is the dierence between the marginal productivity
of each employed worker and the real wage, cumulated over all workers. Hence, the owners of the specic factor in the import-competing
sector lose due to the fact that they have to pay higher real wages
to all workers, and that there are less workers from which they can
extract rents.)
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9. Consider an economy with two countries (North and South), producing

two goods, C and T , with the same technology using two factors, H and L,
both mobile across sectors but not across countries. Good C is relatively
H-intensive, and North is relatively H-abundant. If skill-biased technical
change increases the productivity of skilled workers (H) in both countries,
then:
(a) the relative price of the skill-intensive good falls and skilled workers
are worse o in the North and better o in the South
(b) the relative price of the skill-intensive good increases and skilled
workers are better o in the North and worse o in the South
(c) the relative price of the skill-intensive good falls and skilled workers
are better o in both countries if the increase in their relative productivity more than compensates the fall in the relative price of the
skill-intensive good (right: higher relative productivity implies that
skilled workers contribute more to production and hence should be
paid more. On the other hand, it also implies that the relative supply
of the skill-intensive good increases, which tends to reduce its relative price and hence the relative wage of skilled workers. Depending
on which eect dominates, SBTC will raise or reduce the skill premium. In class, we sa that the former may happen if the elasticity of
substitution between skill and non-skill intesive goods is higher than
one.)
(d) the relative price of the skill-intensive good increases and skilled
workers are better o in both countries since their relative wage always increases by more than the relative price of the skill-intensive
good
10. Consider two countries with the same preferences and using the same technology to produce two goods with two factors, labor and capital. Capital
outows from one of them towards a third country closed to trade:
(a) makes workers worse o in both countries (right: irrespectively of the
source country, capital outows from the integrated economy implies
a drop in the relative endowment of capital and hence a reduction
in the relative supply of capital-intensive good, which increases its
relative price. Since capital is now worthier, its relative price will
also increase, and by more (Stolper-Samuelson eect), which will
make capitalists better o and workers worse o, in both countries)
(b) makes workers better o in both countries
(c) makes workers worse o in both countries if capital ows out of the
capital-abundant country
(d) makes workers worse o in both countries if capital ows out of the
labor-abundant country