Consider a world composed of two countries, Home (H) and Foreign (F). Individuals living in each country i H, F have preferences over two goods x and y. In each country there is only one factor of production, labour, which is perfectly mobile between industries but immobile between countries. The total labour endowment at Home is LH = 10 and the total labour endowment in Foreign is LF = 10. The marginal product of labour in each industry is constant. At Home, one worker can produce 2 units of good x or 1 unit of good y per unit of time; at Foreign one worker can produce 1 unit of good x or 2 units of good y per unit of time.
Consider a world composed of two countries, Home (H) and Foreign (F). Individuals living in each country
i H, F have preferences over two goods x and y.
In each country there is only one factor of production, labour, which is perfectly mobile between industries but
immobile between countries. The total labour endowment at Home is LH = 10 and the total labour endowment
in Foreign is LF = 10.
The marginal product of labour in each industry is constant. At Home, one worker can produce 2 units of
good x or 1 unit of good y per unit of time; at Foreign one worker can produce 1 unit of good x or 2 units of good
y per unit of time.
Assume that consumers in Home and Foreign always consume goods x and y in the same quantity regardless
of their prices. That is, Cxi = Cyi, i = H, F
A. Calculate the
and Foreign.
B. Derive the production possibilities frontier (
the horizontal axis and good y in the vertical axis.
C. Determine the
under autarky – that is, when they do not trade with each other. Explain why any other price could not be
the equilibrium price in autarky.
D. Determine the optimal consumption and production at Home and Foreign under autarky. Depict this situation
in a graph that includes each country’s PPF and indifference
E. Assume that Home and Foreign open to trade with each other. Explain how is the pattern of trade (which
good will each country export and import) determined
F. Suppose that the equilibrium price of good x (keeping the price of good y as 1) is equal to 1. Determine the
optimal production and consumption both at Home and Foreign when they open up to trade. Depict this in
graph.
G. Explain how is the production structure (i.e. which goods are produced) affected in each country by opening
up to trade. Is this consistent with the empirical evidence we observe in reality? How can this model be
modified to produce a less stark result?
H.
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