Question 1

In the monetized Classical model, if trade is not balanced, the international terms of trade will deteriorate for the country with the trade deficit. Explain why this is so.

Accepted Answer

In the monetized Classical model, if trade is not balanced, the international terms of trade will deteriorate for the country with the trade deficit. This is because in a situation where a country consistently imports more than it exports, it will have to pay for the excess imports with its own currency. This will lead to a decrease in the value of the country's currency relative to the currencies of its trading partners.

As the country's currency depreciates, its terms of trade will deteriorate because it will have to exchange more of its own currency to obtain the same amount of foreign goods. This means that the country will have to give up more of its own goods and services in order to pay for the same amount of imports, leading to a decrease in its standard of living.

Additionally, a deteriorating terms of trade can also lead to inflation in the country with the trade deficit, as the cost of imports increases. This can further erode the country's competitiveness in the international market and lead to a downward spiral of economic decline.

Overall, in the monetized Classical model, a trade deficit can lead to a deterioration of the international terms of trade for the country with the deficit, ultimately impacting its economic well-being.

Question 2

In the basic Classical model, only the limits to the international terms of trade can be specified. If the two country-two commodity model is monetized using an exchange rate and a wage rate for each country, the international terms of trade are implicitly specified. Explain why this is so.

Accepted Answer

In the basic Classical model of international trade, often associated with David Ricardo's theory of comparative advantage, the terms of trade between two countries are determined by the relative costs of production of two commodities. The limits to the international terms of trade are set by the opportunity costs in each country. The terms of trade must lie between the opportunity costs of the two countries for trade to be mutually beneficial. However, the exact terms of trade within these limits are not specified by the model itself.

When the model is monetized, meaning that we introduce an exchange rate and wage rates for each country, the international terms of trade become more explicitly defined. Here's why:

1. **Exchange Rate**: The exchange rate is the price at which one currency can be exchanged for another. It allows us to convert the cost of goods from one country's currency into another country's currency. By establishing an exchange rate, we can compare the prices of goods between countries directly. This comparison gives us a clearer picture of the terms of trade because we can now express the value of exports in terms of the value of imports directly.

2. **Wage Rate**: The wage rate is the amount of money paid per unit of labor. In a monetized model, the wage rate reflects the cost of labor in each country. Since labor is a significant component of production costs, knowing the wage rates helps to determine the cost of producing each commodity in each country. When we know the production costs, we can better estimate the prices at which countries will be willing to trade.

By introducing these monetary factors, we can calculate the international terms of trade more precisely. The terms of trade, in this case, would be the ratio of the exchange rate-adjusted price of the commodity from one country to the exchange rate-adjusted price of the commodity from the other country. This ratio would implicitly reflect the relative wage rates and productivity levels of the two countries, as well as the exchange rate between their currencies.

In summary, monetizing the two country-two commodity model by including exchange rates and wage rates allows for a more explicit specification of the international terms of trade. It does so by providing a direct method for comparing the costs and prices of goods between countries, which are influenced by the exchange rate and the cost of labor as reflected in wage rates. This leads to a more precise understanding of at what rate the goods will be exchanged internationally.

Question 3

It is common to read statements to the effect that domestic inflation or production cost increases hinder our ability to export and also stimulate imports. Is this consistent with the Classical view of international trade? What effects would such an event have on the overall economy according to Classical thinking?

Accepted Answer

The statement that domestic inflation or production cost increases hinder our ability to export and stimulate imports is not consistent with the Classical view of international trade. According to Classical economics, a country's ability to export is determined by its comparative advantage in producing goods and services, not by domestic inflation or production costs. In fact, Classical economists believe that a country can benefit from importing goods and services that it cannot produce as efficiently, while focusing on exporting goods and services in which it has a comparative advantage.

In the Classical view, if domestic inflation or production cost increases were to occur, it would lead to a decrease in the country's competitiveness in the global market. This could result in a decrease in exports and an increase in imports, as foreign goods and services become relatively cheaper compared to domestically produced ones. This could lead to a trade deficit and a decrease in the overall economic well-being of the country, as it would be less able to benefit from international trade.

Overall, according to Classical thinking, domestic inflation or production cost increases would have a negative impact on the overall economy, leading to a decrease in exports, an increase in imports, and a potential trade deficit. This is in contrast to the idea that such events hinder our ability to export and stimulate imports, as suggested in the statement.

Question 4

In the three-country world in Question #19, which one of the following statements is TRUE?
A) Posttrade prices (terms of trade) of 1 wheat:2.5 clothing (or 1 clothing:0.4 wheat)Would give all the gains from trade to the United States.
B) Posttrade prices (terms of trade) of 1 wheat:3 clothing (or 1 clothing:? wheat) are Possible.
C) At posttrade prices (terms of trade) of 1 wheat:1.6 clothing (or 1 clothing:0.625 Wheat), England would export wheat and Spain and the United States would export clothing.
D) At posttrade prices (terms of trade) of 1 wheat:2.25 clothing (or 1 clothing:0.44 Wheat), Spain would export clothing and import wheat.

Accepted Answer

At posttrade prices (terms of trade) of 1 wheat:1.6 clothing (or 1 clothing:0.625 Wheat), England would export wheat and Spain and the United States would export clothing. This is because England has a comparative advantage in producing wheat, while Spain and the United States have a comparative advantage in producing clothing. The posttrade prices reflect the relative strengths of each country's comparative advantage and allow for mutually beneficial trade to occur.

Question 5

In Question #11 above, suppose that one-half day of labor must be used to transport a Good internationally, no matter which good is considered and which country is doing the Exporting. With this addition of transportation costs, England will export good(s) __________ and will import good(s) __________.
A) A; B, C, D, and E
B) A and D; B, C, and E
C) A; B, C, and E
D) A; B and C

Accepted Answer

With the added transportation cost, England will only export Good A since it has the comparative advantage in producing it. However, it will also import Goods B, C, and E due to their lower opportunity cost in their respective countries. Good D will not be imported since England has a comparative advantage in producing it even with the added transportation cost.

Question 6

The following Classical-type table shows the number of days of labor input required to obtain one unit of output of each of the two commodities in each of the three countries:
$\begin{array} { l l l } 
&\underline{ \text { clothing }} & \underline{\text { wheat }} \
\text { Spain } & 3 \text { days } & 6 \text { days } \
\text { United States } & 2 \text { days } & 5 \text { days } \
\text { England } & 4 \text { days } & 6 \text { days }
\end{array}$

Given this information, the United States has an absolute advantage over Spain in
A) both goods, and the United States also has an absolute advantage over England in Both goods.
B) both goods, but the United States has an absolute advantage over England in neither Good.
C) neither good, but the United States has an absolute advantage over England in both Goods.
D) neither good, and the United States also has an absolute advantage over England in Neither good.

Accepted Answer

The United States requires fewer days of labor input than Spain to produce one unit of both clothing and wheat, indicating an absolute advantage in both goods. Similarly, the United States requires fewer days of labor input than England to produce one unit of both clothing and wheat, indicating an absolute advantage in both goods.

Question 7

Set up a Ricardo-type comparative advantage numerical example with two countries andtwo goods. Explain how trade between the two countries can benefit each of them in comparison with autarky. Then indicate a situation in which only one of the two countries would gain from trade and carefully explain why only one country gains.

Accepted Answer

The answer of Set up a Ricardo-type comparative advantage numerical...

Question 8

In a two-country Classical model of trade with many commodities, briefly explain what would happen to the structure of trade in each of the following cases:(a) an increase in wages in one country;
(b) a change in the exchange rate;
(c) an improvement in productivity (lowering of the labor requirements/product) in one
country; and
(d) an increase in transportation costs.

Accepted Answer

The answer of In a two-country Classical model of trade...

Question 9

You are given the following Classical-type table showing the output of 10 days labor in the production of each of the two commodities in each of the two countries. Assume that The U.K. worker's wage is £30 per day and that the fixed exchange rate is $2 = £1.
$\begin{array}{lll}
&\underline{\text { Food }}&\underline{\text { Clothing }}\\
\text { United States } & 30 \text { units } & 30 \text { units } \
\text { United Kingdom } & 20 \text { units } & 15 \text { units }
\end{array}$

If trade is taking place between the two countries, what is the "upper limit" to the U.S.Worker's wage per day?
A) $30
B) $40
C) $90
D) $120

Accepted Answer

The U.K. worker earns £30 per day, which is equivalent to $60 per day (since $2 = £1). The U.S. worker must earn less than or equal to this amount to remain competitive, so the upper limit is $120 per day.

Question 10

In the context of the Classical (Ricardo) model, explain, for each of the following two statements, why the statement is either TRUE or FALSE.
(a) "If country A can produce all goods with less labor time per unit of
output than can country B, then there can be no reason for country A
to trade with country B - country A would always maximize its own
welfare by satisfying its consumption desires for all goods from its
own production."
(b) "If country I's workers have greater productivity in all industries
than country II's workers, then workers in country I will be paid a
higher wage rate than workers in country II."

Accepted Answer

The answer of In the context of the Classical (Ricardo)...

Question 11

Given the following Classical-type table shows the number of days of labor input Required to obtain one unit of output of each of the three commodities in each of the two Countries:
$\begin{array} { l l l l } 
&\underline{ \text { good T }} & \underline{\text { good X} } & \underline{\text { good Y }} \
& & & \
\text { United Kingdom } & \text { 4 days } & \text { 5 days } & 3 \text { days } \
\text { United States } & 4 \text { days } & 4 \text { days } & \text { 2 days }
\end{array}$
Suppose that the wage rate in the United Kingdom is £30 per day, the wage rate in the United States is $40 per day, and the exchange rate is £1 = $1. In this situation, the United Kingdom will
A) export good T and import goods X and Y.
B) export good Y and import goods T and X.
C) export goods T and X and import good Y.
D) export goods X and Y and import good T.

Accepted Answer

To determine which goods countries should export or import, we need to compare the opportunity costs of producing each good domestically. Opportunity cost refers to the value of the next best alternative forgone.

In the United Kingdom, the opportunity cost of producing one unit of T is 4/30 = 2/15 units of Y or 4/5 units of X. The opportunity cost of producing one unit of X is 5/30 = 1/6 units of Y or 4/5 units of T. The opportunity cost of producing one unit of Y is 3/30 = 1/10 units of X or 2/15 units of T.

In the United States, the opportunity cost of producing one unit of T is 4/40 = 1/10 units of Y or 1 unit of X. The opportunity cost of producing one unit of X is 4/40 = 1/10 units of Y or 1 unit of T. The opportunity cost of producing one unit of Y is 2/40 = 1/20 units of X or 1/10 units of T.

Comparing the opportunity costs of the two countries, we see that the UK has a comparative advantage in producing good T and X, while the US has a comparative advantage in producing good Y. Therefore, the UK should export T and X and import Y, while the US should export Y and import T and X.

Therefore, the correct answer is C) export goods T and X and import good Y.

Question 12

You are given the following Classical-type table indicating the number of days of labor input needed to make one unit of output of each of the five commodities in each of the Two countries. Assume that the wage rate in England is £20 per day, that the wage rate in Portugal is 40 euros per day, and that the fixed exchange rate is £1 = 3 euros.
$\begin{array}{llllll}
&\text { Good A } &\text { Good B } & \text { Good C }& \text { Good D } &\text { Good E }\
\hline\text { England } & 1 \text { day } & 5 \text { days } & 2 \text { days } & 1 \text { day } & 4 \text { days } \
\text { Portugal } & 4 \text { days } & 4 \text { days } & 1 \text { day } & 2 \text { days } & 5 \text { days }
\end{array}$

With the given information, what will be the trade pattern if the two countries engage in Trade?
A) England will export good A and import goods B, C, D, and E.
B) England will export goods A and D and import goods B, C, and E.
C) England will export goods A, B, and E and import goods C and D.
D) England will export goods A, B, D, and E and import good C.

Accepted Answer

England has a comparative advantage in producing goods A and D because it requires fewer days of labor to produce these goods compared to Portugal. For goods B, C, and E, Portugal requires fewer or the same number of days as England, indicating a comparative advantage or equal efficiency for Portugal in these goods. Therefore, England will likely export goods A and D, where it is more efficient, and import goods B, C, and E, where Portugal is more efficient or equally efficient.

Question 13

In Question #15 above, if the U.S. wage rate is $40 per day and the exchange rate is £1 = $1, what is the upper limit to the wage rate in the United Kingdom that is consistent with Two-way trade between the countries?
A) £26? per day
B) £30 per day
C) £32 per day
D) £40 per day

Accepted Answer

The upper limit to the wage rate in the United Kingdom that is consistent with two-way trade between the countries would be the same as the U.S. wage rate when converted using the exchange rate. Since the exchange rate is £1 = $1, the upper limit to the wage rate in the UK would be £40 per day, matching the U.S. wage rate of $40 per day. This ensures that the cost of labor, and thus the cost of production, does not disadvantage either country in trade.

Question 14

Suppose that, in a Classical model with two goods, Germany can produce 50 units of steel with one day of labor and 30 units of textiles with one day of labor; Switzerland can produce 45 units of steel with one day of labor and 45 units of textiles with one day of labor. If the exchange rate is fixed at 1 Swiss franc = 1 euro and if the Swiss wage rate is 10 francs per day, then, in trading equilibrium, German wages
A) must be greater than 10 euros per day.
B) must be less than 10 euros per day.
C) must be equal to 10 euros per day.
D) can be above, below, or equal to 10 euros per day - cannot be determined without More information.

Accepted Answer

The answer of Suppose that, in a Classical model with...

Question 15

In the context of the Classical/Ricardo model, suppose that, in an industry X, the Productivity of U.S. workers is three times the productivity of Chinese workers. At the same time, suppose that the wage rate paid to Chinese workers is 20% of the wage rate paid to U.S. workers. In this situation, the unit labor cost of producing good X would be __________ in China than in the United States and therefore, in this two-country Classical/Ricardo context, __________.
A) lower; China would export good X to the United States
B) lower; the United States would export good X to China
C) higher; China would export good X to the United States
D) higher; the United States would export good X to China

Accepted Answer

The unit labor cost is calculated by dividing the wage rate by productivity. Even though U.S. workers are three times as productive, their wage rate is five times higher than that of Chinese workers (100% vs. 20%). This means the unit labor cost in China is lower, making China more competitive in producing good X, leading to China exporting good X to the United States.

Question 16

In the situation in Question #13 above, if trade is taking place, what is the "lower limit" to the U.S. worker's wage per day?
A) $30
B) $40
C) $90
D) $120

Accepted Answer

The U.S. worker cannot be paid less than the minimum wage in the U.S., which currently stands at $7.25 per hour. Assuming an 8-hour workday, the worker cannot be paid less than $58 per day. However, if the worker is being compared to workers in Mexico who are paid $30 per day, then the U.S. worker may be paid no less than double that amount, or $60 per day. Therefore, the "lower limit" to the U.S. worker's wage per day would be $60 if trade is taking place. 
Therefore, the correct choice is C.

Question 17

(a) Explain the Dornbusch-Fischer-Samuelson (DFS) model of Classical-type trade between two countries in a very large number of goods. Be sure to describe why each curve slopes as it does, and indicate the trading pattern at the equilibrium position.
(b) Now suppose that, from your equilibrium position in part (a) above, there is a uniform improvement in labor productivity in one of the two countries in all industries. (You can choose either country.) Illustrate and explain what happens to the trading pattern and to relative wage rates. Then explain the impact of the productivity improvement on real income in each country.

Accepted Answer

The answer of (a) Explain the Dornbusch-Fischer-Samuelson (DFS) model of...

Question 18

(a)  Set up a Ricardo-type comparative advantage numerical example with two countries and two goods.  Distinguish “absolute advantage” from “comparative advantage” in the  context of your example.  Then explain how trade between the two countries benefits each of them in comparison with autarky.

(b)  For your numerical example in part (a) of this question, assign a wage rate to one of your countries and a fixed exchange rate between the two currencies.  Then, using your wage rate and the exchange rate, indicate the upper and lower limits to the wage rate in the other country that are consistent with two-way trade between the countries, and explain why these are the upper and lower limits.

Accepted Answer

The answer of (a)  Set up a Ricardo-type comparative...

Question 19

In a five country-two commodity Classical model of trade, where the autarky price ratios in all five countries are different, can you conclude a priori that all five countries will desire to trade? Why or why not? Between which of the five countries is trade certain? What will determine which of the remaining countries will trade?

Accepted Answer

The answer of In a five country-two commodity Classical model...

Question 20

In a Ricardo-type model, if Portuguese workers can produce three times as much wine per Day as English workers but only twice as much cloth per day as English workers, then, if Portuguese wages are 30 euros per day, the upper limit to English wages per day is __________. (Assume 1 euro = £1.)
A) £10
B) £15
C) £60
D) £90

Accepted Answer

In a Ricardo-type model, wages are determined by the productivity of labor. If Portuguese workers can produce three times as much wine as English workers per day, then their productivity ratio is 3:1. Similarly, if Portuguese workers can produce twice as much cloth as English workers per day, then their productivity ratio is 2:1.

Given that Portuguese wages are 30 euros per day, we can use the productivity ratios to calculate the upper limit of English wages. We can start by assuming that English wages are x euros per day.

Then, using the productivity ratios, we can say that Portuguese workers can produce 3x euros worth of wine and 2x euros worth of cloth in a day. Similarly, English workers can produce x euros worth of wine and 1x euros worth of cloth in a day.

Since wages are equal to the value of output produced, we can equate the value of output produced by Portuguese workers and English workers:

3x euros (Portuguese wine) + 2x euros (Portuguese cloth) = x euros (English wine) + x euros (English cloth)

Simplifying this equation, we get:

3x + 2x = 2x + x 
5x = 3x

x = 30/5 = 6

Therefore, the upper limit to English wages per day is 6 euros, which is equivalent to £6. Since the answer choices are in pounds, we can convert this amount using the given exchange rate of 1 euro = £1. Thus, the answer is £6 x 1 = £6.

However, we need to be careful when choosing the answer, as the question asks for the upper limit of English wages, not the actual amount. The upper limit is the maximum wage that English workers can earn while still maintaining a comparative advantage in cloth production. We can calculate this upper limit as follows:

The opportunity cost of producing one unit of cloth in England is one unit of wine. Therefore, the maximum wage that English workers can earn while maintaining a comparative advantage in cloth production is the amount that equals the price of one unit of wine in Portugal:

1 unit of wine in Portugal = 3x euros = 3 x 6 euros = 18 euros

Using the exchange rate of 1 euro = £1, we get:

18 euros = £18

Therefore, the upper limit to English wages per day is £18, which is equivalent to answer choice B.

Quiz 4: Extensions and Tests of the Classical Model of Trade

In the monetized Classical model, if trade is not balanced, the international terms of trade will deteriorate for the country with the trade deficit. Explain why this is so.

In the basic Classical model, only the limits to the international terms of trade can be specified. If the two country-two commodity model is monetized using an exchange rate and a wage rate for each country, the international terms of trade are implicitly specified. Explain why this is so.

In the three-country world in Question #19, which one of the following statements is TRUE?

In Question #11 above, suppose that one-half day of labor must be used to transport a Good internationally, no matter which good is considered and which country is doing the Exporting. With this addition of transportation costs, England will export good(s) and will import good(s) .

In Question #15 above, if the U.S. wage rate is $40 per day and the exchange rate is £1 = $1, what is the upper limit to the wage rate in the United Kingdom that is consistent with Two-way trade between the countries?

In the situation in Question #13 above, if trade is taking place, what is the "lower limit" to the U.S. worker's wage per day?

In a Ricardo-type model, if Portuguese workers can produce three times as much wine per Day as English workers but only twice as much cloth per day as English workers, then, if Portuguese wages are 30 euros per day, the upper limit to English wages per day is __________. (Assume 1 euro = £1.)