1 ECO 441—Fall 2015 Prof. Miguel Iraola Name _________________________ Problem Set #2 (Due Wednesday, November 9) 1. Heckscher-Ohlin Model: Suppose that a free-trade equilibrium exists in a two-country, two-good, two-factor world. Assume that the two goods, chemicals (C) and electronic appliances (E), both employ capital (K) and labor (L), and that both factors are perfectly mobile across sectors. Also assume that: • The US is relatively capital-abundant • Mexico is relatively labor-abundant. • Chemicals are relatively capital-intensive. • Electronic appliances are relatively labor-intensive. • Assume that tastes and technologies are identical in the two countries. (a) On the graph below, sketch the relationship between relative product price, relative factor price and relative factor use in each industry in the US and Mexico. (Under the assumption of identical technologies, the same curves can be used to describe the relationships in both the US and Mexico.) (L/K) wage-rental ratio (w/r) (P E / P C ) 2 Relative Quantity of Electronics (Q E / Q C ) Relative price of Electronics (P E / P C ) (b) On the graph below, sketch & label the relative supply curves of the two countries. • Briefly explain why they differ: • Then, sketch & label the world relative supply curve. RD 3 (c) Using the graph in part (a), label the relative price of electronics, the relative wage (w/r), and each industry’s relative employment of labor-to- capital in each country prior to trade (i.e. in autarky). Then make the following comparisons (write >, <, or =): (PE/PC)US ______ (PE/PC)Mexico (w/r)US ______ (w/r)Mexico (KE/LE)US ______ (KE/LE)Mexico (KC/LC)US ______ (KC/LC)Mexico (d) Before trading, is the real wage higher in the US or Mexico? Briefly explain why. (e) Now suppose that the US and Mexico trade freely. Which good will Mexico export to US? (f) Describe the effect of free trade on: • The relative price of electronics (PE/PC) in the US.: increases/decreases • The relative wage (w/r) in the US: increases/decreases Briefly explain why: • The real wage in the US: increases/decreases Briefly explain why: • The real wage in Mexico: increases/decreases Briefly explain why: 4 (g) Of the four groups below, who are the “winners” and who are the “losers” from the freeing of trade between the US and Mexico? • Capital owners in the US: winners/losers • Capital owners in Mexico: winners/losers • Workers in the US: winners/losers • Workers in Mexico: winners/losers (h) Suppose the PPF for the US is given by the graph below. Using this graph, demonstrate that in theory, all individuals in the US could be made better off by trading freely with Mexico. • Briefly describe what sort of policy would be necessary in practice to make every individual bette ...