ECON 2450 Chapter Notes - Chapter 1: Chlordiazepoxide, Diminishing Returns, Real Wages

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10 Feb 2016
AP/ECON 3150 International Trade
Problem set 2
Problem 1
Canada and U.S. trade two products with each other - Automobiles (A)
and Cloth (C). Each product is produced using labour only but there are two
types of workers in each industry: Skilled (S) and Unskilled (U). Unskilled
workers can easily change occupation and move from one industry to another
if they can earn more there. Skilled workers, however, cannot change occupa-
tion because their skills are speci…c to the industry in which they work. For
example, in the clothing industry there is no demand for skilled mechanics
who spent most of their lives assembling cars. Using classroom terminology,
Uis a mobile factor of production, while SAand SCare ‘speci…c factors’-
a skilled auto worker can only work in Automobile industry, and a skilled
clothing worker can only work in a clothing industry. Both auto and clothing
industries experience diminishing returns to each type of labor. Also assume
that Canada is relatively better than U.S. in producing cars.
a. Draw a PPF diagram for Canada. Justify its shape and compare it to
the U.S. PPF. Put cars on horizontal axis.
b. Assume that preferences of Canadian and U.S. consumers are repre-
sented by some indi¤erence curve U(same for both countries):Draw two
diagrams that show Canadian and U.S. no-trade equilibrium, i.e. equilib-
rium output and consumption of each good and equilibrium relative prices.
Explain how to …nd equilibrium relative price. Compare Canadian and U.S.
relative prices.
c. Suppose that once Canada started to trade with the U.S., the equi-
librium price of cloth, pT
C, has decreased relative to no-trade price, while
the price of cars remains the same. This implies that pT
pA. Show what
would happen to production and consumption in Canada? Which good would
Canada export? Illustrate gains from trade.
d. Use a diagram similar to Figure 3.11 of the class notes (Class 3) to
illustrate the e¤ect of trade on the wage rate of unskilled workers. How does
trade a¤ect real earnings of unskilled workers?
e. What is the impact of trade with the U.S. on earnings of skilled workers
in Canadian auto and clothing industries?
Problem 2
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