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UNIVERSITY OF TORONTO Faculty of Arts and Science

DECEMBER 2012 EXAMINATIONS


ECO364H1F: International Trade

Assistant Professor Peter M. Morrow


Duration - 3 hours
December 19th, 2012 (7pm-10pm)
EX100

Place your NAME and ID NUMBER on your scantron form.

Fill in the information below:

Last Name (Surname)______________________________


First Name (Given)______________________________

Student ID _________________________

INSTRUCTIONS

1. This exam has 15 pages including the cover sheet. Make sure that you have all of
them.
2. Do not open this exam until you are told to do so. STOP work immediately when
told to do so.
3. Place your NAME and ID NUMBER on your scantron form.
4. This exam has 100 points and is in two parts: Multiple Choice (15 questions @ 3
points each=45 total points) and two Long Questions (55 total points). For all
questions, there is no penalty for guessing.
5. For the long question, clearly mark your final answer.
6. Your scantron will not be returned to you. Be sure to mark your answers on the
exam booklet so that you will later have a record of your answers.
7. You are allowed to use simple (non-programmable) calculators. Programmable
calculators are forbidden. Cell phones, blackberrys, PDA’s, iPhones, and all
devices that can contain programmable information are forbidden.
8. Do not cheat.

GOOD LUCK!

  1  
1) Suppose that there are two factors of production: skilled labor (S) and unskilled labor
(U). The following time series data plot the skill premium (wS/wU) and the relative use of
skilled labor in a given industry (Si/Ui).

6  

5  

4  

3  

2  

1  

0  
1990   1991   1992   1993   1994   1995   1996   1997   1998   1999   2000   2001  

Skill  Premium   Si/Ui  

Taking the average change between 1990 and 2001, which of the following models is/are
consistent with the above data?

a) The basic Heckscher-Ohlin model for a relatively skilled labor scarce country opening
up to trade.
b) The basic Heckscher-Ohlin model for a relatively skilled labor abundant country
opening up to trade.
c) A developing country upgrading the “quality” of their exports as argued by
Verhoogen (2008).
d) [the data above is inconsistent with each of the models in (a)-(c).]
e) [the data above is consistent with more than one of the models in (a)-(c).]

2) Assume that the results associated with the homogenous firms IRTS model hold. Also
assume that Canada is currently in a state of free trade with the United States. Now
assume that due to hurt feelings regarding the results of a Winter Olympics hockey game,
the two countries decide to revert to autarky. Due to this, the number of Canadian firms
_________, the number of products available to Canadians ______, mark-ups in Canada
________, and prices in Canada __________.

a) falls; falls; rise; rise.


b) rises; rises; fall; fall;
c) falls; rises; rise; fall.
d) rises; falls; rise; rise.
e) falls; falls; fall; rise.

  2  
3) Consider the Ricardian model with two goods: cars (C) and food (F). Consider the
graph below for France in free trade. The solid line represents France’s PPF and the
dashed line depicts its budget constraint. Qi and Ci represent production and
consumption, respectively.

QF

CF

QF

CC QC QC
Which of the following statements is true?

a) France exports food and imports cars.


b) France is completely specialized in the production of cars.
c) The free trade relative price of cars to food is lower than the autarky price.
d) France is better off if it completely specializes in production of cars.
e) France cannot do anything to achieve a higher indifference curve given the information
in this picture.

4) Given the HO model, consider the following factor allocations with two factors:
skilled labor (S) and unskilled labor (U). There are two goods: computers (C) and textiles
(T).
SC = 250 ST = 50 UC = 50 UT = 50

Suppose that immigration from a highly developed country increases the endowment of
skilled labor by 160. The stock of unskilled workers and factor prices are unchanged.
What is the new allocation? What theorem is this related to?

a) SC = 450 , ST = 10 , UC = 90 , UT = 10 ; Stolper Samuelson.


b) SC = 450 , ST = 10 , UC = 90 , UT = 10 ; Rybczynski.
c) SC = 350 , ST = 110 , UC = 80 , UT = 20 ; Stolper Samuelson.
d) SC = 350 , ST = 110 , UC = 80 , UT = 20 ; Rybczynski.
e) SC = 440 , ST = 20 , UC = 88 , UT = 20 ; Rybczynski

  3  
5) Consider the model of firm heterogeneity. Suppose that the fixed costs of production
fall. Because of this the minimum productivity necessary to operate will be ________ and
average productivity in the economy will ___________.

a) higher; rise.
b) higher; fall.
c) lower; rise.
d) lower; fall.
e) unchanged; be unchanged.

6) According to the data presented in class, in 1990, 2000, 2010, exports of automobiles
accounted for at least _________% of total Canadian exports.

a) 15
b) 25
c) 50
d) (a)-(c) are all correct.
e) (a)-(c) are all wrong.

7) Consider the results of Autor, Dorn, and Hanson (2011) regarding the effect of
Chinese imports on labor market outcomes. Which of the following three statements
regarding people in locations that were more exposed to Chinese exports after 1990 is
consistent with their results?

i) They were less likely to be in the labor force.


ii) Those in the labor force were more likely to be unemployed.
iii) Workers were less likely to possess a college degree.

a) (i) only
b) (ii) only
c) (iii) only
d) (i) and (ii) only
e) (i), (ii), and (iii) only.

8) Consider the Heckscher-Ohlin model with two countries: Russia and Europe. There
are two goods, oil (O) and food (F), and two factors of production: land (T) and labor (L).
Russia possesses 17 million km2 and 141 million people. Europe possesses 22 million
km2 and 739 million people. Russia and Europe are considering a movement from
autarky to free trade. For everyone to win from trade, there must be transfer payments
from ________ to ________ in Russia and from ________ to ________ in Europe.

a) workers; land owners; workers; land owners.


b) land owners; workers; land owners; workers.
c) workers; land owners; land owners; workers.
d) land owners; workers; workers; land owners.
e) workers; workers; land owners; land owners.

  4  
9) Consider the graph below plotting imports into Canada from China divided by total
Canadian imports. Units on the vertical axis are % such that the vertical axis ranges from
0% to 12%.
Imports into Canada From China (%)
12"

10"

8"

6"

4"

2"

0"
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
Which of the following statements is/are implied by the chart?

a) From 2001 to 2005, the share of imports into Canada from China roughly doubled.
b) Between 2010 and 2011, the share of imports into Canada from China fell.
c) The total value of imports into Canada from China was higher in 2008 than it was in
2006.
d) (a) and (b) are correct.
e) (a), (b), and (c) are all correct.

10) Consider the basic Ricardian model with two goods: computers (C) and textiles (T).
Where Ci is consumption of good i, the utility function is

U = CC0.5CT0.5 .

Assume that the economy possesses 1000 units of labor and that the unit input
requirements are as follows
aC = 50 aT = 10 .

Given this information, the autarky relative price of computers to textiles is ________,
autarky production of computers is _______, and autarky production of textiles is
_______.

a) 5; 10; 50.
b) 5; 50; 10.
c) 5; 25; 25.
d) 1/5; 50; 10.
e) 1/5; 25; 25.

  5  
11) Consider the Heckscher-Ohlin model in which there are two countries (USA and
Canada) and two goods: oil (O) and cars (C). There are two factors: land and labor.
Consider the world relative supply-relative demand graph from the HO model in which
(pO/pC)W is the free trade world relative price of oil to cars.

pO
RSUSA
pC

RS CAN

W
( pO / pC )

RD1

QO
QC
Based on the graph above, which of the following statements need not be true?

a) Canada exports oil and imports cars.


b) The United States exports cars and imports oil.
c) Canada possesses a relative abundance of land.
d) The United States possesses a relative abundance of the factor that is used relatively
intensively in the production of cars.
e) In the movement from autarky to free trade, the relative price of oil to cars falls in the
United States.

12) Consider the three following jobs:

i) A hotel receptionist who deals with unpredictable and non-standard demands


from guests.
ii) A data entry specialist who copies numbers out of a book into a Microsoft
excel spreadsheet.
iii) A lawyer who draws up standardized contracts but also occasionally meets
with clients to clarify details.

Please order these from most to least routine.

a) (i), (ii), (iii)


b) (i), (iii), (ii)
c) (iii), (i), (ii)
d) (ii), (iii), (i)
e) (iii), (ii), (i)

  6  
13) Out of the top 10% of the US income distribution, which of the following groups saw
the largest proportional increase in their income share since 1983? Define “income share”
as the proportion of aggregate income that accrues to people in that percentile.

a) 90th-95th percentiles.
b) 95th-99th percentiles.
c) 99th and above percentile.
d) All three groups in (a), (b), and (c) had identical growth in their income share.
e) The growth in income share for the 90th-95th percentiles and 95th-99th percentiles were
similar and both were larger than the growth for those in top 1% of the income
distribution.

14) The data on firm heterogeneity suggests that exporting firms are _________
productive than firms that only sell domestically. The basic model of firm heterogeneity
assumes that the _____________.

a) more; high productivity causes exporting.


b) more; exporting causes high productivity.
c) less; exporting diminishes productivity.
d) less; high productivity firms choose not to export.
e) more; exporting causes productivity and productivity also causes exporting.

15) Given the graph below and the homogenous firms IRTS model, assume that there are
n0 firms each charging a price P0. Which of the following statements apply to this point?

P, AC

P0

n0 n
a) Marginal revenue is greater than marginal cost; profits are negative.
b) Marginal revenue is greater than marginal cost; there are zero profits.
c) Marginal revenue is less than marginal cost; profits are negative.
d) Marginal revenue is less than marginal cost; profits are positive.
e) Marginal revenue equals marginal cost; profits are positive.

  7  
Long Answer I
The Heckscher-Ohlin Model
(28 Points)

Consider the Heckcher-Ohlin model of international trade and the case of New Zealand.
There are two goods: sweaters (S) and milk (M). Assume that there are two factors of
production: sheep (S) and land (T). Assume that production functions are as follows:

QS = SS1/5TS4/5 QM = SM4/5TM1/5 .

The utility function is as follows where Ci is consumption of good i:

U = CS1/3CM2/3 .

Assume that New Zealand possesses 1 million sheep and 300,000 km2 of land. Denote
the wage of sheep by wS and the return to land by r.

a) Starting from profit maximization conditions, derive the relative factor demand curves.
Which good is relatively sheep intensive? Show your work. (8 points)

Sweaters Milk

1 4
wS = pS SS−4/5TS4/5 wS = pM SM−1/5TM1/5
5 5

4 1
r= pS SS1/5TS−1/5 r= pM SM4/5TM−4/5
5 5

wS 1 TS wS T
= =4 M
r 4 SS r SM

As can be seen from the expressions above, sweaters are relatively land intensive
and milk is relatively sheep intensive.

  8  
b) Starting with the utility function, derive the relative demand curve. Show your work
(6 points)

From utility maximization, we know that relative prices equal the marginal rate of
substitution which is equal to the ratio of marginal utilities

∂U
pS ∂CS
=
pM ∂U
∂CM

∂CS1/3CM2/3 1 −2/3 2/3


CS CM
pS ∂CS 3
= =
pM ∂CS1/3CM2/3 2 C1/3C −1/3
S M
∂CM 3

pS 1 CM
=
pM 2 CS

c) Assume that New Zealand possesses a relative abundance of sheep and is open to free
trade. In the graph below, draw the PPF, budget constraint (iso-value line), and
equilibrium indifference curve. Label equilibrium production and consumption points
although you do not need to calculate precise values. (7 points)

  9  
d) Now assume that due to climate change, demand for sweaters increases. Draw how all
of the curves and points change from part (c) including the initial curves with dashed
lines. Again, you do not need to calculate precise values. (7 points)

  10  
Long Answer II
Firm Heterogeneity
27 Points

Consider the model of firm heterogeneity based on monopolistic competition and


increasing returns. Assume that each firm faces the following demand function and
accompanying marginal revenue curve
"1 %
qi = S $ − b ( pi − p )'
#n &
q
MRi = pi − i
Sb
Where MRi, pi, qi are marginal revenue, price and quantity for firm i. S is the market size,
b is a price sensitivity parameter, and p is the average price charged by all firms in the
economy. As in the standard firm heterogeneity model, firm i incurs marginal cost ci and
a per-period fixed cost f.

a) In the graph below, draw the marginal revenue and demand curves facing firms.
Consider three firms:

- Firm 1: positive total profits.


- Firm 2: zero total profits.

Draw the marginal costs curves for these two firms: c1, c2. Also illustrate profit
maximizing quantity produced and price charged for these three firms q1, q2, p1, p2,
respectively. (6 points)

  11  
b) Solve for quantity qi for a firm that earns zero total profits in terms of S, f, and b. Show
your work.
(2 points)

Start with the expression for firm level profits

π i = pi qi − ci qi − f = ( pi − ci ) qi − f

Now set MR=MC


qi
pi − = ci
Sb
Solving for the mark-up

qi
pi − ci =
Sb

Combining this expression with that for profits

qi2
π i = pi qi − ci qi − f =
−f
Sb
Setting profits equal to zero, we can obtain the quantity at which profits equal zero

qi2
− f = 0 ⇒ qi* = Sbf
Sb

c) Using your answer from part (b) combined with the demand function, what are profits
for firm i (πi) as a function of firm productivity ci, market size (S), the number of firms
(n), the price sensitivity parameter b, fixed costs f, and average prices in the economy p ?
(2 points)

Recall that the demand function and profits, respectively, are

"1 % qi2
qi = S $ − b ( pi − p )' πi = −f
#n & Sb .

Also recall that MR=MC


qi
pi − ci =
Sb

  12  
Combining the demand function with the MR=MC expression, we obtain

(1 " q %+
qi = S * − b $ i + ci − p '-
) n # Sb &,
Simplifying
S "1 %
qi = $ − b ( ci − p )'
2 #n &
Recall that the profit function is
qi2
πi = − f
Sb
Combining these two expressions, we obtain the answer

2
S "1 %
π i = $ − b ( ci − p )' − f
4b # n & .

d) Solve for the “producitivity” (1/ci) of a firm earning zero profits as a function of
market size (S), the number of firms (n), the price sensitivity parameter b, fixed costs f,
and average prices in the economy p ? (3 points)

Using our answer from part (c), we know

2
S "1 %
π i = $ − b ( ci − p )' − f
4b # n &

To solve for the level of productivity that sets profits to zero, we simply set this to
zero and solve for ci.

2
S "1 %
π i = $ − b ( c* − p )' − f = 0
4b # n &

1 f
c* = + p−2
bn Sb .

  13  
e) In the graph below, draw the total profit function for domestic sales. Clearly label the
range of firms that go out of business (exit) and that stay in business (produce).
(2 points).

f) Now suppose that the firm can export to another country that is identical in all aspects.
Specifically, assume that S, b, n, and p are the same in this other country. However, to
export, there is an additional fixed cost fx. Solve for total profits for a firm that both
exports and sells domestically as a function of firm productivity ci, f, fx, market size (S),
the number of firms (n), the price sensitivity parameter b, and average prices in the
economy p . (3 points)

For domestic and export sales, respectively, we can write the demand and profit
maximizing conditions

"1 % qi
qi = S $ − b ( pi − p )' pi − ci =
#n & Sb
and

"1 % qiEX
qiEX = S * $ * − b ( piEX − p * )' piEX − ci =
#n & Sb

Combining these expressions, we obtain

  14  
S "1 %
qi = $ − b ( ci + p )'
2 #n &
and

S* " 1 %
qEX
i = $ * − b ( ci − p * )'
2 #n & .

We can use these to derive the export profit function

EX 2
q 2 ( qi )
π i = i + * − f − fX
Sb Sb ,

2 2
S "1 % S* " 1 %
π i = $ − b ( ci + p )' + $ * − b ( ci − p * )' − f − f X
4b # n & 4b # n & .

g) Present the separate profit functions for domestic and total (domestic and foreign)
sales on the graph below. Clearly label the range of firms that i) goes out of business, ii)
only produces domestically, and iii) produces for both domestic and export markets.
Assume that all three types of firms exist. (5 points)

  15  
h) Solve for the productivity level ci at which a firm is indifferent between selling on both
markets and selling only for the domestic market. (2 points)

We can do this by setting profits from exporting equal to profits from only selling
domestically

2 2 2
S "1 % S* " 1 * % S "1 %
$# − b ( ci + p )'& + $# * − b ( ci − p )'& − f − f X = $# − b ( ci − p )'& − f
4b
 n 4b
n  4b
n  .
profits from exporting and selling domestically Profits from domestic sales

2
"1 * % 4bf X
$# * − b ( ci − p )'& = *
n S

1 f
c X* = *
+ p * − 2 *X
bn Sb

i) If the fixed costs of trade fall (fx), does the pool of exporters become more or less
productive on average? (2 points)

As is clear from the above expression, if the fixed costs of trade fall, then less
productive (or higher marginal cost) firms can now export. This leads to exporters
becoming less productive on average through composition effects.

  16  

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