1. Suppose that the United States and Canada have the factor endowments in the f
ID: 1141803 • Letter: 1
Question
1. Suppose that the United States and Canada have the factor endowments in the following table. Suppose further that the production requirements for a unit of steel are 2 machines and 8 workers, and the requirement for a unit of bread is 1 machine and 8 workers. United States Canada Capital 40 machines 10 machines Labor 200 workers 60 workers
a. Which country is relatively more labor-abundant? Which country is relatively more capital-abundant? Explain your answer.
b. Which good, bread or steel, is relatively capital-intensive? Labor-intensive? Explain your answer.
c. What is the range for the relative price of bread such that the US economy produces both bread and steel? Which good is produced if the relative price is outside of this range?
d. Which country would export bread? Why?
e. Suppose that before trade takes place, the United States is at a point on its PPC where it produces 20 loaves of bread and 20 units of steel. Once trade becomes possible, the price of a unit of steel is 2 units of bread. In response, the United States moves along its PPC to a new point where it produces 30 units of steel and 10 units of bread. Is the country better off? How do you know?
f. Explain what happens to the returns to capital and labor after trade begins.
Explanation / Answer
ANSWER:
a) Labor abundant: Canada; Capital-abundant: U.S.
Explanation: The capital-labor ratios for the U.S. and Canada are are 1/5 and 1/6. Because1/5 is greater than 1/6, United States is capital abundant; and as the labor-capital ratio is higher in Canada, thus it is labor abundant
b) Labor relative: Bread; Capital-relative: Steel
Explanation: Because capital-labor ratio to make bread is 1/8 and to make steel is 1/4
c) When relative price is outside of the range, none of goods can be produced because economy cannot produce above PPF
d) Canada will export bread and the U.S. will export steel
Explanation: Because United States capital abundant and steel is capital intensive, thus applying the Heckscher-Ohlin trade model, Canada will export bread and the U.S. will export steel.
e) The United States will be better off because it can buy a higher quantity of both goods. If it traded five steel for 10 breads, the nation will have 20 bread and 25 steel. It is the same same amount of bread as before trade, and five additional units of steel. U.S. can keep the extra five steel, or trade few or all of them for additional bread. In either scenario, the consumption bundle is higher than it was before the trade.
f) The changes in the returns to capital vary by nation. In United States., the demand for capital rises because more steel will be produced; conversely, the demand for labor declines due to the the fall in bread production. Owners of capital gains from the increase in demand for their inputs and owners of labor suffer a reduction in their returns (wages). The effects are reversed in Canada.
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