EXERCISES

INTERNATIONAL ECONOMICS

Teresa Lloyd Braga

Filipa Santos Silva
1. Consider two Ricardian economies, N and E, which produce and consume two
goods, apples (X), and potatoes (Y). In country N there are 1200 workers and production
of one unit of good X needs in average 3 workers, while the production of one unit of
good Y needs in average 2 workers. In country E there are 800 workers and production
of one unit of good X needs in average 5 workers, while the production of one unit of
good Y needs only 1 worker.

a) Represent graphically the Production Possibilities Frontier of N and E.

b) What’s the opportunity cost of X in terms of Y in each economy?

c) In the absence of international trade, what is the relative price of X in terms of Y in

each economy?

d) Represent graphically the world relative supply curve.

e) Suppose that the world relative demand is X / Y = py / px, and that there is free trade
between the two countries.

e1) What’s the equilibrium relative price of X, with international trade?

e2) Describe the pattern of trade.

e3) Show that each country has gains from trade.

e4) Compare the real wages, in each country, before and after the trade.

f) Suppose that N has now 2400 workers.

f1) What is, in the new world equilibrium, the relative price of X?

f2) Describe the new pattern of trade.

f3) Show the gains from trade.

g) Assume that N has now 2400 workers but those workers have only half of the
productivity they had before. What will happen?

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2. The next table shows how many units of goods T and R can be produced, with
1 hour of labor, in England and in the USA, in 4 different situations:

Situation A Situation B Situation C Situation D

USA UK USA UK USA UK USA UK

T 4 1 4 1 4 1 4 2

R 1 2 3 2 2 2 2 1

a) For each situation, identify the commodities in which the USA and the UK have an
absolute advantage.
b) For each situation, identify the commodities in which the USA and the UK have a
comparative advantage.
c) For each situation show if there is any economic advantage for free trade, describing,
in the affirmative case, the pattern of trade.

3. Consider two Ricardian economies, A and B, which produce and consume two
goods, X and Y. The world relative supply is graphically represented by the S curve.
The world relative demand can be represented by D1 , D2 or D3 depending on the
situation.
py px

a yB axB S
D1
a yA a xA
D3 D2
LA a yA QyA  QyB
LB a xB QxA  QxB

For each situation:

a) Describe the pattern of specialization and trade.
b) Show the gains from trade for economies A and B.

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4. Assume Portugal has a total supply of 100 hours of labor hours, and produces
two goods, X e Y. In 1 hour, Portugal can produce 4 units of good X or 1 unit of good
Y. In the world market, the equilibrium relative price of X, ( px / py ), is 2.
a) Explain if free trade is beneficial to Portugal.
b) Represent graphically the production possibilities frontier of Portugal indicating the
production point with free trade. Show the consumption possibilities available to
Portugal in the open / trading economy.

5. In Argentina one unit of labor produces 1 bicycle or 10 pounds of wheat. In

Brazil 8 units of labor produce 2 bicycles or 8 pounds of wheat.
a) What is the opportunity cost of bicycles in terms of wheat for Argentina and for
Brazil?
b) In which good does Brazil have a comparative advantage? And Argentina?

6. S and V are closed economies. They produce two goods, Rice (Y) and fish flour
(X), using only labor. S has 150 workers and V has 84 workers. The unit labor
requirements in country S are 0.5 workers per unit of rice, and 2 workers per unit of
fish flour. In country V the unit labor requirements are 0.3 workers per unit of rice, and
1 worker per unit of fish flour. Suppose that preferences in each country are identical
and homothetic, being described by the following utility function: U = XY.
a) Explain if there is any advantage in free trade between both countries.
b) Under free trade determine:
i) the world equilibrium relative price;
ii) the consumer equilibrium, the production equilibrium and the amount of
exports and imports in each country.
c) Are there any gains from trade for country S and country V? Represent the consumer
possibilities frontier, in case of free trade, for both countries.
d) What will be the relative wage between S and V in case of free trade? Make some
comments.

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7. Consider two Ricardian economies, N e E, that are able to produce the goods x,
y and z according to the unit labor requirements provided below.

x y z

N 1 3 2

E 3 1 2

Assume the existence of free trade.

a) Is it possible for N to export x e y? Justify.
wE 1
b) What will be the pattern of trade if the relative wage between N e E is  ?
wN 2

c) Assume that z has transport costs. Is it possible that this good becomes a nontraded
good?

8. Consider a country, A, which economy is described by:

X  4k x0.75 l x0.25 ; Y  4k y0.25l y0.75 ; U  XY

L  100 ; K  10

Suppose all markets are perfectly competitive markets and both factors are perfectly
mobile between sectors.
A. Consider that country A is under autarky.
a) Show that technologies exhibit constant returns to scale.
b) Determine and represent graphically:
i) The relation between the relative price of goods, p  p y p x and the relative
price of factors, w r ;

ii) The relation between factor intensities in production of X and Y and the
relative price of factors, w r .

C9 Determine the “contract curve” for production and represent it graphically

(allocation of resources in a two factor economy using a “box diagram”).

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 y 30 p 2  1
d) The relative supply curve is given by the expression:  .
x p 3  10 p 2 

i) Represent it graphically.
ii) What’s the Marginal Transformation Rate evaluated at the point of the
Production Possibilities Frontier where the country is producing only good Y (i.e.,
x  0 )?
iii) What’s the Marginal Transformation Rate evaluated at the point in the
Production Possibilities Frontier where the country is producing only good X (i.e.,
y  0 )?
e) Determine the equilibrium in this country, before liberalization of international trade
– relative price of goods, relative price of factors, real remuneration of labor and capital,
and factor intensities in both industries.
B. Consider now free trade and that the world equilibrium relative price is
 
p y p x *  0.2 . Determine:

a) The pattern of trade;

b) Real remuneration of labor and capital after trade;
c) Knowing that country B has the same technologies as country A,
i) Which country is abundant in capital?
ii) Compare real remunerations of factors, in both countries, after trade.
iii) Suppose that meanwhile the amount of capital endowment increases in
country B. Will this fact have any influence in the pattern of trade?

9. Consider an economy, with perfectly competitive markets, with fixed

endowments of labor and land, producing two goods, rice and wheat, using technologies
with constant returns to scale and without intensity reversal. Because of free trade the
consumption of wheat falls and the real remuneration of labor rises.
a) In which good does this country have comparative advantages?
b) In which factor is rice relatively intensive? Justify.
c) What is the influence of free trade on the total amount of labor employed in producing
wheat?
d) How does the land intensity change in the production of rice and wheat due to free
trade?

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10. Two countries,  and  , produce two goods, M (labor intensive) e N (capital
intensive). Technologies are identical across countries and exhibit constant returns to
scale. The endowment of capital is identical across countries, but  has a smaller total
amount of labor. Next figure represent the autarkic equilibrium points (A and B) of
country  and of country  :


 A B

a) Which country is abundant in capital? Justify.

b) In point A, is the economy producing in its Production possibilities Frontier? Why?

c) Identify the comparative advantages of each country and justify.

d) Compare the real wage in  and in  before trade.

e) What is going to happen to real wage in country  , with the liberalization of trade
between  and  ?

11. Consider a model 2x2x2: two countries (A e B), two goods (x e y) and two
factors (L e T). Technologies are identical across countries and without intensity
reversal. At the autarkic equilibrium, the marginal productivity of land (T) relative to
the marginal productivity of labor (L), is higher in country A than in country B.

a) Are there any economic advantages for free trade, if at the autarkic equilibrium
T L X  T L Y in both countries? Describe the pattern of trade.
b) And if at the autarkic equilibrium T L X  T L Y in both countries (possibly
different between countries), are there any economic advantages for free trade? Justify.

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12. The next figure represents the Production Possibilities Frontiers of country A
and B. Preferences are homothetic and ‘identical’ across countries. UU’ is an
indifference curve of a representative economic agent. Industry X is capital intensive
and Y labor intensive, and there is no intensity reversal. Technologies are identical
across countries and exhibit constant returns to scale.

Y U
A
a
c
U’
B LP1

A’ B’ X

a) What could explain the differences between the production Possibilities Frontiers of
countries A and B?
b) Represent, in the Harrod-Johnson diagram, the position of both countries at the
autarkic equilibrium. Which country is labor abundant? Justify.
c) Are there any economic advantages for free trade between A e B? Why? In the
affirmative case describe the pattern of trade and explain the possible sources of
comparative advantage.
d) Suppose that world relative price is defined by LP1. Could we have an international
equilibrium with that price? Justify. Compare the world equilibrium relative price with
that defined by LP1.
e) What is the effect of free trade on real wage of country A? Justify.
f) Are there conditions for the international equalization of factor prices?

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13. In the figure below, α and β represent the consumers’ indifference curves in the
economies A and B. Factor endowments and technologies are identical across countries.
Industry M is capital intensive and industry N is labor intensive. Preferences are
homothetic in both economies.
a) Are there any economic advantages for free trade between A and B? Why? In
the affirmative case describe the pattern of trade and explain the possible sources of
comparative advantage.
b) Compare the real wages in the economies A and B after trade.:
M


14. Consider an economy under free trade with the rest of the world. Preferences are
identical and homothetic.
Suppose that this economy has grown in such a way that its pattern of trade changed.
a) Could this growth be biased toward the original exported good? Justify.
b) Could we observe an immiserizing growth? Why?
c) What are the effects of growth in this economy for the rest of the world?

15. Consider an economy 2x2: two goods (x e y) and two factors (L e T), with
perfectly competitive markets and with free trade. Industry X is capital intensive and Y
labor intensive. Technologies exhibit constant returns to scale. Preferences are
homothetic and ‘identical’ for every agent.
This economy exports good x.
a) What are the effects of a neutral technological progress in industry x:
i) on the contract curve;
ii) on the production possibilities frontier;
iii) on the Harrod-Johnson diagram;
iv) on the relative supply curve x y ;
v) on the relative demand curve x y ;
b) What will happen to the world equilibrium price?
c) Is this growth good or bad for the rest of the world?

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16. Suppose the car market is a monopolistic competitive market.
The cost function of each firm is given by: C  750  5 X and the market demand is
1 1
given by: X  S    P  P   , where n is the number of firms, X the number of cars
 n 30 
produced in a year by each firm and S the total quantity of cars produced and sold by
the industry.
Consider two economies, N and E. Economy N sells 900 cars a year, and economy E
sells 1600 cars a year.
a) Determine the number of firms, the number of cars produced by each firm and the
equilibrium price in both countries, in autarchy..
b) Determine the number of firms, the number of cars produced by each firm and the
equilibrium price with free trade. Are there any gains from trade?

17. Consider a Monopolist, in country N, that faces a demand curve for domestic
sales of good X described by: p  300 x 1 2 , where x represents the number of units
demanded in the domestic market and p represents the price per unit of good X. The
firm’s cost function is given by: C  x 3 2 .
a) What is the optimal level of price and quantity of good X under autarky?
b) Suppose that this firm can also export as much as it wishes at the international price
p *  30 . Ignore the existence of transportation costs and consider that markets are
segmented.
b1) Is the monopolist going to charge a lower price for exported goods than it
does for the same goods sold domestically (Dumping)? Determine:
i) The quantity of X produced by the monopolist;
ii) The quantity of X sold in the domestic market and its price;
iii) The quantity of X sold in the foreign market and its price.
. b2) Compare the producer’s surplus and the consumer’s surplus, in country N,
before and after trade.
b3) What is the value of the international price ( p * ) at which the firm would
decide not to export?
b4) If there were transportation costs, t, per unit exported, how would you
answer b3)?
c) Suppose there are no more transportation costs. Now consumers, in country N, can
buy any quantity of X, in the international market, at the price p *  30 .
i) What is the amount of consumption of good X in country N.?
ii) Determine the volume of trade.
iii) Evaluate the producer’s surplus and the consumer’s surplus, in country N, in
that situation and compare with the autarkic situation.

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18. Consider economy N which has a labor endowment of L N  100 and a capital
endowment of K N  400 , and produces a good Q. The production function is -
Q  K 1 2 L1 2 . Consider another economy E, which has factor endowments of L E  100
and K E  1600 , producing good Q with the same technology as N. All markets are
perfectly competitive.
a) Determine the real returns of factors, for both countries, under autarky.
b) Consider that international mobility of labor is liberalized – workers are allowed to
move between the two countries. Find the effects of free labor movements on:
i) Employment in each country;
ii) Production;
iii) Real price of factors (wages and real rental rates of capital)
c) Consider now, the existence of international capital mobility, instead of international
labor movements. Find the effects of free capital movements on
i) Capital services in each country;
ii) Production;
iii) Real price of factors.

19. Consider two countries, A e B, producing two goods, X e Y, with two factors,
Capital (K ) and Labor (L). Technologies are identical across countries and exhibit
constant returns to scale. There is no intensity reversal.
Preferences are homothetic and identical across countries.
Country A exports good X and imports good Y.
In both countries industry X is produced using a lower Capital per Worker (K / L) ratio
than good Y.
a) Represent, in the Harrod-Johnson diagram, the position of both countries at the
autarkic equilibrium and at the free trade equilibrium.
Suppose that meanwhile the amount of capital endowment increases in country B.
b) Represent graphically, in space (X,Y), the free trade position of A and B, before
and after the increase in B’s capital endowment. Analyze the effects of growth in both
economies.
c) Workers in country A get worried about B’s Growth anticipating big welfare losses
for themselves. Do you agree with that concern? Justify.
Consider now that international mobility of capital is liberalized between A and B.

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d) Find the effects of free capital movements on the real price of factors in country B.
Now suppose that countries A and B establish economic relations with another country
C. Country C is relatively abundant in labor in face of country A and in face of country
B. It is not possible to establish free trade with C but international mobility of capital
between A, B and C is liberalized.
e) Analyze Capital movements between A, B and C.
f) Find the effects of free capital movements on real price of factors in country C.

20. Consider an economy N under autarky, with perfectly competitive markets. The
Supply and the Demand of good X are, respectively, given by: X NS  200  p and
X ND  1100  p .

Consider another economy, E, under autarchy, with perfectly competitive markets. The
Supply and the Demand of good X are, respectively, given by: X ES  400  p and
X ED  1000  p .

a) Determine the equilibrium price, under autarky, for both economies.

b) What is the value of the world equilibrium price under a free trade? What is the
amount of the volume of trade?
c) Suppose economy N imposes a specific tariff of t =100 on imports of good X.
Determine the effects of the tariff on:
i) The price of good X in each country;
ii) The quantity of good X supplied and demanded in each country;
iii) The volume of trade .
d) Determine the effects of trade on the welfare of each of the following groups –
Consumers, producers, government and country. (Surplus analysis)
e) Consider country E offers exporters a subsidy of s  50 per unit exported. Determine
the effects of the subsidy on:
i) The price of good X in each country;
ii) The quantity of good X supplied and demanded in each country;
iii) The volume of trade.
f) Calculate the effects of the subsidy on welfare, both of individual groups and of the
economy as a whole, for both countries.

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