1. Why did the Mercantilists consider holdings of precious metals so important to nation-state building? (6 points)
Wealth was viewed as synonymous with holdings of precious metals. Nation-states wished to become wealthy and this meant obtaining large holdings of precious metals. It is also argued by some that the shortage of coinage constrained the growth of these nation-sates and that precious metals were required to increase the supply of coinage (money) in order for the countries to grow.
2. Assume that both the United States and Germany produce beef and computer chips with the following costs: (12 points)
a. What is the opportunity cost of beef (B) and computer chips (C) in each country?
In the United States: the opportunity cost of one unit of beef is 2 chips; the opportunity cost of one chip is 1/2 unit of beef. In Germany: the opportunity cost of one unit of beef is 4 chips; the opportunity cost of one chip is 1/4 unit of beef. b. In which commodity does the United States have a comparative cost advantage? What about Germany?
The United States has a comparative cost advantage in beef with respect to Germany, while Germany has a comparative cost advantage in computer chips.
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c. What is the range for mutually beneficial trade between the United States and Germany for each computer chip traded? The range for mutually beneficial trade between the United States and Germany for each unit of beef that the United States exports is: 2C < 1B < 4C
d. How much would the United States and Germany gain if 1 unit of beef is exchanged for 3 chips? Both the United States and Germany would gain 1 chip for each unit of beef traded.
3. “If U.S. productivity growth does not keep up with that of its trading partners, the United States will quickly lose its international competitiveness and not be able to export any products, and its standard of living will fall.” Critically evaluate this statement in light of what you have learned in chapter 3 of the textbook. (10 points)
This statement could be true if trade was based on absolute advantage. However, since trade can take place on the basis of comparative advantage, what counts is relative cost differences. Consequently a country can be less efficient or become less efficient in all goods and yet again from trade as long as there are relative cost differences in autarky. Thus, different rates of productivity growth may change what a country exports, but it is unlikely that it would ever take away the basis for trade, its ability to expert.
4. The following table shows the number of days of labor required to produce a unit of textiles and autos in the United Kingdom and the United States: (12 points)
Textiles
Autos
United Kingdom
3 days
6 days
United States
2 days
5 days
a. Calculate the number of units of textiles and autos that can be produced from 1 day of labor in each country.
In the United Kingdom one day of labor can produce 1/3 of a unit of textiles and 1/6 of a unit of automobiles. In the United States, one day of labor can produce ½ of a unit of textiles and 1/5 of a unit of automobiles. b. Suppose that the United States has 1,000 days of labor available. Construct the production-possibilities frontier for the United States.
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500 U.S
c. Construct the U.S. consumption-possibilities frontier with trade if the terms of trade are 1 auto: 2 units of textiles.
500 textiles U.S
d. Select a pre-trade consumption point for the United States, and indicate how trade can yield a consumption point that gives the United States greater consumption of both goods.
500 textiles U.S
5. In the previous question, suppose that the United States always wishes to consume autos and textiles at the ratio of 1 auto to 10 textiles. What quantity of each good would the United States consume in autarky? What combination would the United States consume with trade and complete specialization? What would be the gains from trade? (10 points)
In autarky, the production ( and consumption ) of textiles and autos will utilize all the available 1000 days of labor. Thus, with T = number of units of textiles produced and A = number of autos produced, 1000 = ( 2 days / unit) T + (5 days / unit )A. The consumption requirement is that 10 units of textiles be consumed for every unit of automobiles. Hence, total textile production is equal to (10) ( total auto production), 10A thus, given the available labor, and substituting 10A for T,
1000 = (2)(10A) + 5 A
A= 40 units
If A = 40 units, then textile production and trade, textile production equal 500 units. Consumption of textiles (CT) is equal to textile production minus the textile exports used to enquire auto imports, and auto imports are equal to auto consumption (CA).
With the international terms of trade of 1A:2T, auto imports = (1A/2T)(exports of textiles) = (1A/2T)*(textile production – textile consumption).
By the demand assumption, consumption of auto is also equal to (1/10)(textile concumption).
Hence , CA = (1/2)(500 –CT ) and CA = (1/10)(CT).
Thus,
(1/2)(500- CT) = (1/10)(CT)
250 – (1/2)(CT) = (1/10)(CT)
0.6CT = 250
CT = 416 2/3 units
With Ct = 416 2/3 units, CA therefore equals 41 2/3 Unitts. Because of specialization and trade, the united States had gained 16 2/3 Units of textiles ( 416 2/3 – 400 ) and 1 2/3 ( 41 2/3 – 40 ) in comparison with autarky situation.
Another method of arriving at these results is to utilize the equations for the PPF and for the consumption pattern. In autarky the PPF equation is T = 500 – 2 ½ A, and the consumption equation is CT = 10CA. Solving the two equations for the two unknowns yields A = CA = 40 and T = CT = 400. With trade, the equations to be utilized are for the consumption- possibilities frontier with trade has the equation T = 500 – 2A. When this equation is put with the consumption equation CT = 10 CA and the two equation are solved for two unknowns, the equilibrium results are
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A = CA = 41 2/3
AND
T = CT = 416 2/3
