4 - Resources and Trade

Question 1

Who were the first economists to study the effects of factor endowments on trade?

Answer 1

Eli Heckscher and Bertil Ohlin

Question 2

What are factor endowments?

Answer 2

Refer to the natural resources and assets, such as land, labor, capital, and technology, that a country possesses. These endowments can give a country competitive advantage in certain economic sectors

Question 3

What do countries have in regards to factors of production?

Answer 3

Countries have different “relative abundance” of factors of production

Question 4

What do production processes use?

Answer 4

Production processes use factors of production with different relative intensity

Question 5

ASSUMPTIONS

Answer 5

ASSUMPTIONS

Question 6

How many countries are there?

Answer 6

Two: Home and Foreign

Question 7

How many goods are there?

Answer 7

Two homogeneous goods: Cloth (C) and Food (F)

Question 8

How many factors of production are there?

Answer 8

Two homogeneous factors of production: Labour (L) and Land (T for terrain)

Question 9

Is the supply of land and labour constant in each country and does it vary across countries?

Answer 9

Supply of labour and land is constant in each country and varies across countries, no factor mobility borders

Question 10

Which country is abundant in labour and which country is abundant in land?

Answer 10

• Home country is abundant in labour
• Foreign country is abundant in land
• L/T > L/T

Question 11

Which production is labour intensive and which production is land intensive?

Answer 11

• Cloth production is labour intensive and food production is land intensive:
  Lc/Tc > Lf>Tf

Question 12

What is it called when we allow labour and land to move across sectors within each country?

Answer 12

Substitution of Inputs

Question 13

What is the Law of Diminishing Returns?

Answer 13

Adding one input while holding the other constant leads to decreasing marginal output

Question 14

What is Perfect Competition?

Answer 14

Implies, inter alia, a large number of both producers and consumers, perfect information, zero transaction costs

Question 15

What are factors of production paid due to perfect competition?

Answer 15

Paid their marginal product

Question 16

What do we assume both countries to have the same?

Answer 16

Same technology and same consumer tastes

Question 17

What do we assume there to be none of?

Answer 17

Neither transportation costs nor governmental trade barriers

Question 18

END OF ASSUMPTIONS

Answer 18

END OF ASSUMPTIONS

Question 19

What does the Production Possibility Frontier (PPF) look like due to the law of diminishing returns and because resources are use-specific?

Answer 19

The PPF is bowed outwards, indicating increasing opportunity costs

Question 20

Why is the isoquant convex to the origin in the graph of input possibilities in food production?

Answer 20

Because the two factors are not perfect substitutes, an isoquant is convex to the origin (diminishing marginal rate of technical substitution)

Question 21

What does the PPF describe?

Answer 21

What an economy CAN produce

Question 22

What do we need to determine so we can describe what the economy DOES produce?

Answer 22

The prices of goods

Question 23

In general, what point should the economy produce at?

Answer 23

The point that maximises the value of production, V:
V = PcQc + PfQf

Question 24

What is the slope of the isovalue lines?

Answer 24

• Pc/Pf

Question 25

What point on the isovalue line do we select?

Answer 25

The point on the highest possible isovalue line, Q, maximises the value of production given the output prices the economy faces. At the point, the slope of the PPF equals the slope of the isovalue line, so that opportunity cost of cloth equals the relative price of cloth, Pc/Pf

Question 26

Producers may choose different amounts of factors of production used to make cloth or food, what does their choice depend on?

Answer 26

The wage rate, w, and the rental rate, r

Question 27

What happens if the wage rate increases relative to the rental rate?

Answer 27

Producers use less labour and more land in the production of both food and cloth (recall the food production is land intensive and cloth production is labour intensive)

Question 28

In each sector, what does the ratio of land to labour used in production depend on?

Answer 28

The cost of labour relative to the chost of land, w/r

Question 29

What is the price of a good equal to in competitive markets, and what does this depend on?

Answer 29

In competitive markets, the price of a good equals the cost of production, which depends on factor prices. Changes in w/r are tied to changes in Pc/Pf

Question 30

What would happen as a result of an increase in the wage rate?

Answer 30

An increase in the wage rate will affect the price of cloth more than the price of food, because cloth production is more labour intensive than food production.

Question 31

What is the Stolper-Samuelson Theorem?

Answer 31

If the relative price of a good increases, then the real rate of return of the factor used intensively in the production of that good increases, while the real rate of return of the other factor decreases

Question 32

In a competitive economy, what are the factors of production paid?

Answer 32

Their marginal product (which equals their real rate of return)

Question 33

What happens to the marginal product of a factor as the level of that factor used in production increases?

Answer 33

The marginal product of that factor decreases - By the same token, the marginal product of a factor increases as the level of that factor used in production decreases

Question 34

What are the impact of a fall in the relative price of cloth [Pc/Pf]?

Answer 34

- Lowers in the income of workers relative to that of landowners; - Decrease the ratio of land to labour (T/L] in both industries; - Lower the marginal product of labour in both industries; - Raise the marginal product of land in both industries; - Lower the real income (purchasing power) of workers and increase the real income of land owners

Question 35

An economy with a high ratio of labour to land is predicted to have a high and low what?

Answer 35

- A high output of cloth relative to food - A low price of cloth relative to food

Question 36

Why is this?

Answer 36

- It will be relatively efficient at (have a comparative advantage) in producing cloth - It will be relatively inefficient at producing food

Question 37

When will an economy be relatively efficient at producing certain goods?

Answer 37

An economy will be relatively efficient at producing goods that are intensive in the factors of production in which the country is relatively well endowed

Question 38

If a country is abundant in labour, why is it relatively efficient at producing cloth?

Answer 38

Because cloth is labour intensive - The country's PPF will allow a higher ratio of cloth to food relative to the foreign country's PPF