Economics 190.

1 THQ
3 December 2013
Chapter 3 (Krugman, Obstfeld, and Melitz) Answers:
7. What is wrong with the argument is the basis by which the United States comparative
advantage was made. The basis was that the US was more productive in the service
sector; hence, only the two unit labor requirements (for the service sector of US and
Japan) were used. However, in order to determine comparative advantage, four unit labor
requirements are required: the service ratio and the ratio of another industry (comparing
US and Japan). Therefore, there is no comparative advantage to speak of in the posed
argument.
9. If there would be fewer goods that are traded, then there will be less possible gains from
trade. On the other hand, if there would be more goods that are not traded, then there will
be more possible gains from trade. There would be no gains from trade only when
transport costs are too high or there is absence of strong national cost advantages, which
prevents goods from being traded.
Chapter 4 (Krugman, Obstfeld, and Melitz) Answers:
4.a. The effect of the increase in supply of capital to Homes production possibilities curve is
shown in the shift to PP from PP, while showing the increase in the production of good
1 from Q1 to Q1

Q2

PP'
PP

Q1

Q1'

4.b. The relative supply curve for Home and Foreign is shown below as RSHOME and
RSFOREIGN, respectively.
1

Q2

PP'
PP

Q1

Q1'

4.c. Since Home experienced an increase in the supply of capital, Home has higher relative
price for good 1. More laborers would shift from good 2 (whose factor is land) to good 1,
and Home would need to import good 2 instead. Therefore, as the two economies open up
to trade, Home will export good 1, while Foreign will export good 2.
4.d. As Home opens up to trade, labor moves from good 2 to good 1, and there will be more
use of capital and less use of land since Home will produce more of good 1 than good 2.
Meanwhile, as Foreign opens up to trade, labor moves from good 1 to good 2, and there
will be more use of land and less use of capital since Foreign will produce more of good
2 than good 1.
5. Free movement of labor from Home to Foreign will reduce laborers in Home and raise
the real wage in Home, while the Foreign labor force will increase and the Foreign real
wage to decrease. As a result, Homes productivity increases while Foreigns productivity
declines. On the other hand, Foreign landowners will gain from the inflow of workers
with the decrease in real wages and increase in output, while Home landowners will be
hurt by the outflow of workers with the increase in real wages and decrease in output.
6.a. Workers originally in Foreign will experience a decrease in their income from having a
wage of 18 to 16.
6.b. Foreign landowners income will increase because of higher output as a result of the
inflow of the two laborers from Home, and the said decrease of Foreign workers real
wage from 18 to 16.
6.c. Workers who stay in Home will experience an increase in their income from having a
wage of 10 to 12.

6.d. Home landowners income will decrease because of lower output as a result of the
outflow of the two laborers to Foreign, and the said increase in Home workers real wage
from 10 to 12.
6.e. The workers who do move will experience a wage increase of 6, from 10 to 16.