Problem Set 2

2.	a.	State each of the following theorems, which are based on the Heckscher-Ohlin model: (1) the Heckscher-Ohlin (HO) theorem, (2) the factor-price equalization (FPE) theorem, and (3) the Stolper-Samuelson (SS) theorem.
	b.	Consider South Korea, a small country which starts out as relatively labor-abundant.
		(1)	What does the Heckscher-Ohlin theorem predict for South Korea's pattern of trade when it it is a labor-abundant country?
		(2)	Illustrate an initial PPF for South Korea, putting capital-intensive products on the horizontal axis. Then suppose that South Korea promotes a high rate of domestic savings and capital formation. Illustrate how the country's production possibilities frontier will change over time.
		(3)	Could growth of this type eventually reverse South Korea's direction of trade? Explain briefly.

3.	Suppose you download some data about Denmark, a small, capital-abundant country. The data report the percentage price changes resulting from Denmark's move to freer trade for each of the following items: Denmark's export products, import-substitute products, labor and capital. Unfortunately, the data got scrambled. All you end up with are the following unlabeled percentage changes: +16%, -8%, -20%, +40%. According to the Heckscher-Ohlin model, how would you match these values and what they most likely correspond to? Explain briefly.

Suppose the home country is capital-abundant and that there are two types of products, capital-intensive advanced goods (A) and labor-intensive basic goods (B), produced with two resources, capital (K) and unskilled labor (L). Different people have different employment situations and different consumption patterns too.
In each cell of the table below, use the notation "+, -, 0, ?" to indicate whether Heckscher-Ohlin style free trade would cause the individual's welfare to rise, fall, remain the same or change in an uncertain direction. Briefly explain how you made your decisions.

	Consumption pattern
Endowment/Employment:	a: Consumes only A	b: Consumes some A and B	c: Consumes only B
A. An owner of capital used in the advanced goods industry
B. An owner of labor employed in the advanced goods industry
C. An owner of capital used in the basic goods industry
D. An owner of labor employed in the basic goods industry

5.	Decide whether each of the following is or is not consistent with the HO model, and explain your decision in each case:
	a.	"You implement that Nafta (the North American Free Trade Agreement),...and you're going to hear a giant sucking sound of jobs being pulled out of this country...."
	b.	"[For the U.S.,] Nafta's benefits would fall on skilled labor, while the unskilled would suffer a slight decline in real income."
	c.	"An unrestricted U.S.-Mexico free-trade agreement will be a disaster for [unskilled] workers in both countries."
	d.	With Nafta, overall, "American [unskilled] workers would benefit from the increased supply of lower-cost Mexican products and from increased U.S. sales to Mexico."
	e.	"International wage-cutting competition...shifts our desirable high-wage and skilled industries and jobs to other countries."
	f.	For a capital-abundant country, in the long run, free trade will raise the price of unskilled labor in the country's export industries and lower the price of unskilled labor in the country's import-competing industries.

Other trade models

Consider the following breakdown of the export markets of DCs and LDCs:

	Share of exports sold to...
	DCs	LDCs
DC exports	72%	28%
LDC exports	55%	45%

Which trade is most clearly accounted for by the HO model? Why?

What sorts of trade might be especially prominent for the other cases?

7.	Suppose that steel output in South Korea is produced by a domestic monopoly.
	a.	Suppose South Korea engages in no trade in steel. Use a domestic-market supply and demand diagram to depict an initial equilibrium in which South Korea's steel monopolist charges a price above the competitive equilibrium. Label the monopoly price Pm, and label the efficient competitive price Pc.
	b.	Now suppose that the world price of steel is between Pm and Pc. Depict South Korea's free-trade equilibrium. Indicate South Korea's ordinary gain from trade and its additional gain from trade due to the competition introduced into its steel industry.

8.	As always, don't forget to staple your work.

1.	a.	State the formula for a country's terms of trade.
	b.	The terms of trade for many lesser developed countries (LDCs) have been declining for many years. Decide whether the following is true or false, and use the Terms of trade indexes handout to support your answer: "Rising terms of trade is a necessary and sufficient condition for economic growth."