HOMEWORK 5 (HECKSCHER-OHLIN THEORY) ECO41 FALL 2011 UDAYAN ROY

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1 HOMEWORK 5 (HECKSCHER-OHLIN THEORY) ECO41 FALL 2011 UDAYAN ROY Each correct answer is worth 1 point. The maximum score is 20 points. This homework assignment is due on Monday, October 31. Please show your answers on the answer sheet (on the last page). 1. Consider a world in which the assumptions of the Heckscher-Ohlin theory are true. Suppose there are two countries, Australia (A) and Brazil (B), and two resources, capital (K) and labor (L), that are used to produce two goods, cloth (C) and food (F). The amounts of K and L that A and B are endowed with are given in the adjoining table. Which of the following is true? Resource Endowments Capital (K) Labor (L) Australia 100 machines 50 workers Brazil 10 machines 20 workers a. Australia is capital abundant and Brazil is labor abundant b. Australia is labor abundant and Brazil is capital abundant c. Australia is capital intensive and Brazil is labor intensive d. Australia is labor intensive and Brazil is capital intensive e. Australia has more of both resources. So, Australia is both capital abundant and labor abundant 2. Consider a world in which the assumptions of the Heckscher-Ohlin theory are true. Suppose there are two countries, Australia (A) and Brazil (B), and two resources, capital (K) and labor (L), that are used to produce two goods, cloth (C) and food (F). Suppose that on a particular day you visit several cloth factories in Australia. You find that they are employing the amounts of resources shown in the adjoining table. Resource Employment Capital (K) machines Labor (L) workers Capital-Labor ratio (K/L) machines per worker Factory Factory Factory Which of the following is true? a. Factory 1 must be paying either a lower price for capital than the other factories (or a higher price for labor), which is why it is using more capital per worker than the other factories b. Factory 1 must be using a technology that either makes better use of capital than the other factories (or worse use of labor), which is why it is using more capital per worker than the other factories. c. The data given here is impossible under Heckscher-Ohlin assumptions. In that theory, all firms use the same technology. Moreover, as resource markets are assumed to be perfectly competitive, it is impossible for different factories to be paying different prices for capital and labor. As a result, under Heckscher-Ohlin assumptions, all firms in a country must employ capital and labor in the same proportions d. The use of capital and labor in different ratios in different cloth factories is perfectly consistent with Heckscher-Ohlin assumptions

2 3. Consider a world in which the assumptions of the Heckscher-Ohlin theory are true. Suppose there used to produce two goods, cloth (C) and food (F). Suppose that on a particular day you visit several cloth factories in Australia and several food factories, also in Australia. You find that all cloth factories are using 1 unit of capital per worker and that all food factories are using 3 units of capital per worker a. This means that cloth is the labor-intensive good and food is the capital-intensive good b. This means that cloth is the capital-intensive good and food is the labor-intensive good c. The technology used in production need not be the same in the two countries. Therefore, although the capital per worker ratio is higher for food production in Australia, in Brazil it could instead be higher for cloth production. So, under Heckscher-Ohlin assumptions, you cannot tell which good is capital-intensive and which good is labor-intensive by looking at just one country d. Under Heckscher-Ohlin assumptions, both countries have the same technology. So, if in Australia the capital per worker ratio is higher in food production (compared to cloth production), then the same must be true in Brazil as well. Therefore, if cloth is labor intensive in Australia, then it must be labor intensive in Brazil too e. Both (a) and (d) are correct 4. (2 points) Consider a world in which the assumptions of the Heckscher-Ohlin theory are true. Suppose there are two countries, Australia (A) and Brazil (B), and two resources, capital (K) and labor (L), that are used to produce two goods, cloth (C) and food (F). The amounts of K and L that A and B are endowed with are given in the adjoining table. Resource Endowments Capital (K) Labor (L) Australia 100 machines 50 workers Brazil 10 machines 20 workers Suppose also that on a particular day you visit several cloth factories in Australia and several food factories, also in Australia. You find that all cloth factories are using 1 unit of capital per worker and that all food factories are using 3 units of capital per worker. Then, according to the Heckscher-Ohlin theory, under free trade a. Australia, the capital-abundant country, will export food, the capital-intensive good b. Australia, the capital-abundant country, will export food, the labor-intensive good c. Australia, the labor-abundant country, will export food, the capital-intensive good d. Australia, the labor-abundant country, will export food, the labor-intensive good e. Australia, the capital-abundant country, will export cloth, the capital-intensive good f. Australia, the capital-abundant country, will export cloth, the labor-intensive good g. Australia, the labor-abundant country, will export cloth, the capital-intensive good h. Australia, the labor-abundant country, will export cloth, the labor-intensive good 5. In Australia the wage (w) is 10 Australian dollars (AUD) per hour, and the price of food (P F ) is 2 AUD per pound. Then the real wage in units of food -- defined as the amount of food that could be bought with one hour's wage -- is calculated a. by the formula w P F and is equal to 20 pounds of food 2

3 b. by the formula w/p F and is equal to 5 pounds of food c. by the formula w + P F and is equal to 12 pounds of food d. by the formula w - P F and is equal to 8 pounds of food 6. Consider a world in which the assumptions of the Heckscher-Ohlin theory are true. Suppose there In autarky, the real wage -- defined as the amount of food that can be bought with an hour's wage -- will be a. higher in Australia if food is the labor intensive good b. higher in Brazil if food is the labor intensive good c. higher in Australia d. higher in Brazil e. the same in both Australia and Brazil 7. Consider a world in which the assumptions of the Heckscher-Ohlin theory are true. Suppose there In autarky, a. the real wage in units of food will be higher in Australia, and the real wage in units of cloth will be higher in Brazil, if food is the labor intensive good b. the real wage in units of food will be higher in Australia, and the real wage in units of cloth will be higher in Brazil, if cloth is the labor intensive good c. both real wages will be higher in Australia d. both real wages will be higher in Brazil e. the real wage in units of food will be the same in both Australia and Brazil, as will the real wage in units of cloth 8. Consider a world in which the assumptions of the Heckscher-Ohlin theory are true. Suppose there In free trade, the real wage -- defined as the amount of food that can be bought with an hour's wage -- will be a. higher in Australia if food is the labor intensive good b. higher in Brazil if food is the labor intensive good c. higher in Australia d. higher in Brazil 3

4 e. he same in both Australia and Brazil 9. Consider a world in which the assumptions of the Heckscher-Ohlin theory are true. Suppose there In free trade, a. the real wage in units of food will be higher in Australia, and the real wage in units of cloth will be higher in Brazil, if food is the labor intensive good b. the real wage in units of food will be higher in Australia, and the real wage in units of cloth will be higher in Brazil, if cloth is the labor intensive good c. both real wages will be higher in Australia d. both real wages will be higher in Brazil e. the real wage in units of food will be the same in both Australia and Brazil, as will the real wage in units of cloth Consider a world in which the assumptions of the Heckscher-Ohlin theory are true. Suppose there used to produce two goods, cloth (C) and food (F). Let the real wage of labor in units of food be the amount of food that can be purchased with an hour's wage. (For example, if, in Australia, the wage is 10 Australian dollar (AUD) per hour, and the price of a yard of cloth is 2 AUD, then the real wage in units of cloth is 5 yards of cloth. The real rental price of capital, whether in units of food or cloth, can be analogously defined.) Assume autarky. Suppose you know that the real wage of labor measured in units of food is currently higher in Brazil. Then it must be true that 10. the real wage of labor measured in units of cloth is in Brazil, 11. the real rental price of capital measured in units of food is in Brazil, and 12. the real rental price of capital measured in units of food is in Brazil. (In each blank, write one of the following words: higher, lower, same, unknown.) 13. (2 points) Consider a world in which the assumptions of the Heckscher-Ohlin theory are true. Suppose there are two countries, Australia (A) and Brazil (B), and two resources, capital (K) and labor (L), that are used to produce two goods, cloth (C) and food (F). Suppose Australia is the capitalabundant country Finally, suppose that food is the capitalintensive good and cloth is the labor-intensive good. If autarky ends and free trade begins, this capital-per-worker ratio (which represents producers' eagerness to use capital rather than labor) will 4

5 a. increase in cloth production and decrease in food production, in Australia. In Brazil, it will be the opposite b. increase in food production and decrease in cloth production, in Australia. In Brazil, it will be the opposite c. increase in both cloth production and food production, in Australia. In Brazil, it will decrease in both the cloth and food industries d. decrease in both cloth production and food production, in Australia. In Brazil, it will increase in both the cloth and food industries e. stay unchanged in both Brazil and Australia f. increase in cloth production and decrease in food production, in both Australia and Brazil. g. increase in food production and decrease in cloth production, in both Australia and Brazil Consider a world in which the assumptions of the Heckscher-Ohlin theory are true. Suppose there Finally, suppose that food is the capital-intensive good and cloth is the labor-intensive good. Let the real wage of labor in units of food be the amount of food that can be purchased with an hour's wage. (For example, if, in Australia, the wage is 10 Australian dollar (AUD) per hour, and the price of a yard of cloth is 2 AUD, then the real wage in units of cloth is 5 yards of cloth. The real rental price of capital, whether in units of food or cloth, can be defined analogously.) If autarky ends and free trade begins, 14. the real wage in units of food will in Australia and in Brazil, 15. the real wage in units of cloth will in Australia and in Brazil, 16. the real rental price of capital in units of food will in Australia and in Brazil, 17. the real rental price of capital in units of cloth will in Australia and in Brazil. (In each blank, write one of the following words: increase, decrease, unchanged, unknown.) 18. "If the conditions of the Factor Price Equalization Theorem are satisfied, free trade in goods will make the standard of living of every human being the same." This statement is: a. True b. False, because free trade equalizes nominal factor prices, not real factor prices, which are what our standard of living depends on c. False, because, although free trade equalizes real factor prices and although each human being is endowed with the same amount of labor, all human beings are not endowed with the same amounts of non-labor resources (such as capital and land). Therefore, real incomes can vary from person to person d. False, because, although free trade equalizes real factor prices, all human beings are not endowed with the same amounts of labor and non-labor resources (such as capital and land). Therefore, real incomes can vary from person to person 5

6 19. For an economy with only two resources, labor and capital, the Factor Price Equalization Theorem says that a. When there is free trade in goods, the nominal wage of a unit of (standardized) labor, w, will become the same in all countries, as will the nominal rental price of a unit of (standardized) capital, r. (Assume that the nominal prices in all countries are converted to the same currency unit using market exchange rates.) b. When there is free trade in goods, w/p x, which is the wage of a unit of (standardized) labor in units of good X, will become the same in all countries, as will r/p x, the analogous price of capital c. When there is free trade in goods, w/p x, which is the wage of a unit of (standardized) labor in units of good X, will become the same in all countries, as will r/p x, the analogous price of capital, provided the free trade in goods is accompanied by the free movement of labor and capital across countries d. w/p x, which is the wage of a unit of (standardized) labor in units of good X, will become the same in all countries, as will r/p x, the analogous price of capital, only if there is free movement of labor and capital across countries. This will be true whether or not there is free trade in goods 6

7 ANSWER SHEET HOMEWORK 5 (HECKSCHER-OHLIN THEORY) ECO41 FALL 2011 UDAYAN ROY NAME: DATE: