Use a blue book to answer the following questions.  Always use graphs where they are helpful, especially if they are suggested, but be sure to clearly label them, and also explain your answers in clear sentences.  Neatness and organization count!  You have until 2:25 PM.  You will still be challenged for time, so manage it well.

1.  (20%) Assume that there are two countries, Usia and Themia, and labor is the only factor of production.  Each country produces only two goods, cloth (Qc) and grain (Qg).  Usia has 100 workers, and each Usian worker is capable of producing either 5 units of cloth or 10 units of grain.  Themia has 200 workers, and each Themian worker is capable of producing either 3 units of cloth or 4 units of grain.  Using only PPFs and indifference curves, show their autarky price ratios and consumption points, assuming each would choose to put half their labor into each good at their own autarky price ratio.  Show how appropriate specialization would increase their combined output of each good, relative to autarky, and then show how international trade at some appropriate price ratio (the terms of trade) could make both countries better off.  Finally, explain how you have just demonstrated the Ricardian theorem of comparative advantage, and explain why Smith's theory of absolute advantage doesn't work as well.

2.  (10%) Using PPFs and indifference curves, demonstrate that specialization and exchange between two countries can improve overall welfare in both of them, if either (a) production possibilities differ or (b) preferences differ.  Explain.

3.  (15%) How does international trade affect the welfare of specific groups within a country?  Compare the predictions of (a) the Ricardian model, (b) the fixed factors model, and (c) the Heckscher-Ohlin model for a country with two products, which you can call Qx (an exportable good) and Qi (an importable good).  What assumptions does each model make about the factors of production?  How would your answer be different if one country's factors were all twice as productive, all things being equal?  How would the availability of compensation affect the willingness of these specific groups to support free trade?

4.  (20%) It has been argued that trading goods intensive in specific factors is an indirect way of trading the factors themselves.  Demonstrate that free trade in goods and a free flow of factors across borders have similar effects.  Assume there are two countries which are identical in technologies, roughly equal in size, have perfectly competitive markets, and use only two factors of production (labor L and capital K) that are not perfect substitutes for each other but are perfect substitutes across industries and borders.  Assume country A is K-abundant, country B is L-abundant, good X is K-intensive, and good Y is L-intensive.  First, use appropriate graphs to demonstrate how country A is affected by free trade in goods, relative to autarky.  How will goods flow, according to the Heckscher-Ohlin theorem?  How does free trade affect output prices and input prices?  Second, assume that free trade in goods is forbidden but free trade in factors is allowed.  How will factors flow across borders?  Why?  What happens to output prices and input prices?  Finally, how are these two sets of results similar, and how are they different?

5.  (15%) Using the general assumptions in question 4 above, show how growth affects both a country and its trading partner.  First, consider the effects of an increase in K through investment.  First, if the country is a small participant in world markets, what would Rybczynski predict would happen to output of each good, X and Y?  If both countries are large participants, what effects would K growth in A have on output prices, input prices, the volume of trade, and overall welfare in both A and B?  Then in comparison, what effects would K growth in B have on output prices, input prices, the volume of trade, and overall welfare in both A and B?  Finally, in which case could K growth be immiserizing, and in which case would such immiserization be impossible?  What other two conditions would need to be met to make immiserizing growth possible?

6.  (10%) Briefly explain briefly the major assumptions behind the Krugman-Obstfeldt model of monopolistic competition, and explain what determines the slopes of both the CC and PP curves.  Then use it to show how international trade affects such an industry.  Assume there are two countries, where Home has a market twice that of Foreign.  Show and explain how the price and the number of firms changes from autarky to free trade.  How does trade thus affect consumer welfare in each country, at least in this industry?  Which country's firms have a competitive advantage?  Would you predict any intra-industry trade?  Why or why not?

7.  (10%) Explain, compare, and contrast (a) internal economies, (b) external economies, and (c) the learning curve arguments for trade.  In which case might free trade prevent a small developing country from specializing in a good with a potential comparative advantage?

Bonus question (for those who are quick and knowledgeable):  Why is international investment so significant, and which way does it flow?  Explain, compare, and contrast the argument for international factor flows you developed in question 4 above - i.e., what if free trade is prevented, but capital can migrate? - with other explanations, including diversification, intertemporal substitution, and capital flight?  What does each explanation predict for the direction of capital investment?

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