GS 29281 Fall, 2013

International Trade Professor Bae

GS 29281
Midterm Exam 2
Solution
< Total points: 50 >

Part 1. (10 points) Multiple Choice. Each question is worth 1 point. Write
down the letter corresponding to the correct answer.

1. (a)

2. (a)

3. (b)

4. (d)

5. (c)

6. (a)

7. (d)

8. (b)

9. (c)

10. (a)

Part 2. (10 points) Short questions. Each question is worth 5 points. Explain
them clearly and logically.

1. The concept of factor abundance is (like factor intensities) a relative

concept. When we identify a country as being capital abundant, we
mean that it has more capital per worker than does the other country.
If one country has more capital workers than another, it is an arithmetic
impossibility that it also has more workers per unit of capital.

1
 2. A social indifference curve shows combinations of consumption bundles
that give an economy the same social utility. When people have a lot
of one good, they are willing to give up a relatively larger amount of it
to get a good of which they have relatively little. Therefore, the social
indifference curve should be a curve.

Part 3. (30 points) Long questions. Each question is worth 15 points. Display
your working.

1.

a. M P LC · PC = M P LF · PF =⇒ (100 − LC ) · 2 = (50 + LC ) · 1.

=⇒ 200 − 2LC = 50 + LC .

Solving for LC , L∗C = 50, L∗F = 50, and w∗ = $100.

b. With the new price, the equilibrium condition is now (100−LC )·4 =
(50 + LC ) · 1,

=⇒ 400 − 4LC = 50 + LC .

Thus, L∗∗ ∗∗
C = 70, LF = 30, and w
∗∗
= $120.

The equilibrium wage rises by 20 % (from $ 100 to $ 120).

c. Both PC and PF rise by 100 %. Therefore, the new prices are now
PC = $4 and PF = $2.

The condition is (100 − LC ) · 4 = (50 + LC ) · 2.

=⇒ 400 − 4LC = 100 + 2LC .

Thus, L∗∗ ∗∗
C = 50, LF = 50, and w
∗∗
= $200.

When both prices increase by 100 %, the equilibrium wage rises by

100 % (from $ 100 to $ 200).

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2.

a. There must be two relative supply curves because of resource differ-

ences across two countries.

PT O
PT E

RS K
RS C

K∗
( PPTT O
E
)1 = ( PPTT O
E
)K •
( PPTT O
E
)∗ -•
( PPTT O
E
)C • C∗

RD

0 QT O
QT E

Without trade, Korea’s equilibrium would be at point K ∗ . Simi-

larly, China’s equilibrium would be at point C ∗ . Since Korea has a
higher ratio of skillful to unskillful labor than China, it produces a
lower ratio of toy to television. On the other hand, China produces
relatively more toys than televisions.

b. A country exports goods when the prices of the goods abroad are
higher than those of the goods domestically produced. This is be-
cause firms could get greater profits when they could sell their prod-
ucts at higher prices in the global markets. When Korea and China
trade with each other, their relative prices converge. The relative
price of toys falls in Korea and rises in China, and a new global
relative price of toys will be determined at a point somewhere be-
tween the pretrade relative prices, K ∗ and C ∗ , along the RD curve.
We know that an economy exports the good whose relative price

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 rises. Therefore, China exports toys to Korea and Korea exports
televisions to China.

c.

QT E −( PPTT OE )2 = −( PPTT OE )∗

XXX −( PPTT OE )1 = −( PPTT OE )K

XXX H
QT E2 •XXHX
6 HXXXX
H
QT E1 H•H
HH
HH
HH
H

QT O2 QT O1 QT O


The initial output levels (QT O1 , QT E1 ) represent production lev-

els for domestic consumption before trade. Once Korea engages in
international trade with China, it produces more televisions than
what it requires to meet its domestic demand for televisions. Then,
it exports the extra televisions produced to China. The increase
in television production results in the reduction in toy production,
given the fixed amount of resources. The shortage of toys in Korea
makes China export toys to Korea.