Question

2. (Ricardian Model) Two agricultural economies, "Home and "Foreign" produce corın (C) and wheat (W). Home has an endowment of 200 fields, each of which can produce either 2 units of corn or 2 units of wheat. Foreign has an endowment of 300 fields, each of which can produce either 1 unit of con or 2 units of wheat. Consus in both economies have identical homothetic preferences represented by the utility function: (a) Draw the production possibility frontiers for both economies (draw the production of corn on the x-axis and of wheat on the vertical axis) (b) Let H/Hv denote the relative price of corn. In the比/Hv-C/W space, draw the relative demand and supply curves for both economies i autarky (use a different diagram for each economy). Make sure to indicate the coordinates of the point where both curves intersect. Do these curves depend on the economies endowments in terms of number of fields? (c) Now assume that these economies open up to international trade. Draw the world relative demand and supply curves on a separate diagram. Indicate on the diagram the coordinates of the intersection point between the two curves and the level of the autarky and free trade relative prices (d) What is the pattern of production, consumption and trade in this trade equilib- rium? Indicate the quantities produced, consumed, exported and/or imported in each country (e) Now assuethat Home's productvity changes: each field can produce the same amount of cor and wheat, but this amuntis now a variable >0 (previously i. How does the equi ade relative price PolPw depend o Clearly indicate how to compute Pc/ Pw given any value of >0. What happens to Home's terms of trade as it experiences productivity growth (r increases)? ii. Investigate how Home's aggregate welfare changes with r. Again, you should clearly indicate how to compute Home's welfare as a function of any r >0 iii. Is immiserizing growth possible in this example? In other words, can Home's welfare decrease with further prodty improvement? Explain.

Answer 1

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