Instructions: Answer all parts. Due in class on Friday, February 17. Any combination of handwritten and computer-printed answers is acceptable. If you work with
classmates (and you may do so on a problem set), you must list the names of everyone you worked with. You are also welcome to consult with the professor or TA for
1. Consider a Specific Factors Model, as developed in Feenstra & Taylor chapter 3, applied to South America in the 19th Century. Suppose that as South America becomes
independent of Spain and Portugal, it “opens up” to free trade and exports agricultural goods (A) and imports manufactures (M). Agricultural goods are produced with
land (T) and labor (LA), while manufactured goods are produced using capital (K) and labor (LM). Thus, land and capital are the immobile (specific) factors while labor
is the mobile factor. a. First, analyze what happens to the equilibrium nominal wage rate W as a result of trade, using a diagram like the figure below, and assuming
that the price of the export good rises (for convenience, you may assume that the price of the imported good stays constant for this diagram). Label all curves and
axes completely and explain your diagram carefully (what shifts and why? how does equilibrium employment change?). Also compare the change in the nominal wage with the
change in the value of the MPL for the export good!
(See the Feenstra & Taylor book or the PowerPoint for a larger version of this graph.)
b. Also draw a production possibility frontier diagram and show the equilibria for South America in autarky (no trade) and with free trade. Does South America get
aggregate gains in consumer welfare from trade? Show these gains on the PPF diagram. c. Then, analyze what happens to real wages in terms of each good, W/PA and W/PM,
and explain your answer. Do workers gain or lose from trade, or what does this depend on? i. What general principle does your answer to this part illustrate? d. Next,
analyze whether the “landlords” (owners of land) and “capitalists” (owners of capital) gain or lose from free trade. Focus on the real rental rates for land and
capital: RT/PA, RT/PM, RK/PA, and RK/PM (you do not have to analyze the percentage changes in RT or RK). i. Does it matter which good the landlords and capitalists
consume more of, A or M? Why or why not? ii. What general principle does your answer to this part illustrate?
e. Based on your answers to parts b-d. combined, what must be true about the gains to the group(s) that gain from trade in South America compared with the losses to
the losers? (Hint: are there aggregate gains to South America as a whole? If so, what does this tell us about the magnitudes of the gains and losses to the different
factor owners?). f. Assuming that the landlords were the richest group in South America in the 19th century, capitalists were the middle class, and workers (labor)
were the poorest group, and also assuming that workers consumed mostly food (agricultural products, A), did free trade make the region’s distribution of income more
equal or more unequal according to this model? Do you think that this pattern of specialization in international trade helped or hindered the long-run economic
development of South America? Why or why not? Discuss both points briefly.