University of British Columbia

Vancouver School of Economics

Economics 355 (921)

Summer Session, Term 1, 2014
M. Vaney

Midterm Examination

Number

Part Points Available Points Earned

A.1 5
A.2 5
A.3 5
A.4 5
B.1 20
B.2 20
Total 60

Time Allowed: 75 Minutes

ANSWER ALL PARTS OF THE EXAMINATION.
PART A: Answer all 4 questions. Each question is worth 5 marks.

1. Two products, Cattle (C) and Wheat (W ), are produced in a country using 3 factors of produc-
tion, Land (T ); Labour (L) and Capital (K). Productivities of each input are constant. There is
a …xed supply of each input in the economy. The following table shows unit input requirements
for each input and each good:
aL aK aT
Cattle 1 1 2
Wheat 3 1 4
The total amount of each input is L = 600, K = 400 and T = 1200. Draw the production
possibilities frontier (Cattle on the horizontal). Measure the opportunity cost of producing
Cattle. Explain whether the opportunity cost of producing Cattle is constant or changing.

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2. What is the real wage? Compare the predictions of the Ricardian model and the Speci…c Factors
model with respect to how the real wage changes as a country moves from autarky to free-trade?

3. Consider the following data regarding production of goods for two countries. (Assume a Ricardian
world, hours of labour is the only input).

Home Foreign
Bicycles/hr 3 2
Snowboards/hr 8 4
w
What is the range of the relative wage w
in a free-trade equilibrium?

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4. Home produces Cloth and Food using two factors of production: Labour and Land. Labour is
used intensively in the production of Cloth and Land is used intensively in the production of
Food. The endowment of Labour at Home is L = 3000 and the endowment of Land at Home is
T = 2000: Explain whether LC = TC is possible in an autarky equilibrium for the Home country
A
( PPCF ). (Drawing a box that shows the resource endowments may be helpful.)

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PART B: Answer both questions. Each question is worth 20 marks.

1. A Ricardian world economy consists of two countries, Home and Foreign. There are two pro-
duction goods, Steel (S) and Toys (T). There is a single factor of production, labour (L). The
technology of production can be described by constant unit-labour requirements that di¤er across
goods and across countries as follows:

Steel Toys
Home aLS = 2 aLT = 2
Foreign aLS = 4 aLT = 12

The size of the Home labour market is L = 1200. The size of the Foreign labour market is
L = 2400. When there is no trade, each country produces both goods for consumption.

(a) Show Foreign’s Production Possibilities and determine the opportunity cost of Steel in the
Foreign country. (4 marks)

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(b) Which country has the comparative advantage in the production of Steel? Find the range
T
of world prices, PPTS where each country specializes in the production of a single good. (5
marks)

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(c) Suppose there is a trade equilibrium where each country specializes in the production of a
single good. Explain whether it is possible for the wages at Home to be 50% higher than
the wages in Foreign? (5 marks)

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(d) Suppose there are two types of consumers in both countries. Steel-lovers who consume
mostly Steel, and Toy-lovers who consume mostly Toys. Explain whether trade bene…ts
one type of consumer more than the other. Is the e¤ect of trade the same in both Home
and Foreign? (6 marks)

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2. Consider a world with two goods, Cloth (C) and Food (F ). There are 2 countries, Home and
Foreign. Home has a comparative advantage/is e¢ cient in the production of Cloth.

(a) Suppose the Ricardian model applies: there is a single factor of production, Labour (L):
The Unit Labour requirement (aLi ) is constant with respect to good i (Cloth or Food) as
is Marginal Product of Labour, M PLi = a1Li . Use a graph to show how the Home country’s
^
Production Possibilities Frontier changes when Home’s Labour force increases from L to L.
Be sure to label axes and note the values of intercepts and slopes. (3 marks)

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(b) For the change in Home’s Labour force in (a); use a graph to show how the World Relative
Supply of Cloth will change, and explain what is likely to happen to the Home country’s
Terms of Trade. Be sure to label axes and note the values of intercepts and slopes. (5
marks)

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(c) Now suppose that the Speci…c Factors model applies: Capital (K) is speci…c to the produc-
tion of Cloth, Land (T) is speci…c to the production of Food and Labour (L) is freely mobile
and required for the production of both goods. If Home’s Labour force increases from L to
^ use a 4-quadrant diagram to derive the new PPF for the Home country. (6 marks)
L;

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(d) As in (c), the Speci…c Factors model applies: Capital (K) is speci…c to the production of
Cloth, Land (T) is speci…c to the production of Food and Labour (L) is freely mobile and
^
required for the production of both goods. If Home’s Labour force increases from L to L;
use a graph to show what happens to the Home wage and employment in both industries
when PC and PF do not change. Explain what will happen to the earnings/returns to all 3
factors, Labour, Capital, and Land. (6 marks)

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