Question

Let us assume a 2x2x2 model (country H & F, good A & B, factors L & K).

The two countries are identical except L < L* and K > K*

More over good A is labor intensive and good B is capital intensive.

(a) Draw the production possibility frontier of the two countries. (You need to measure A on the horizontal axis).

(b) Using factor prices w & r, commodity prices Pa & Pb, derive the relation between the pre trade relative price ratios of good A in H and F. (Correct version: Suppose the relative demand for A is identical in both countries. Using indifference curves for preference, derive the autarky relative price of A in H and F. Using appropriate diagram show the autarky factor price ratio in H and F) ) Show the autarky prices using a graph with world relative supply and relative demands and show the direction of trade.

Answer 1

Solution to Country (H) Good > County) i Country 'H, 'f' production possibility frentiens AB is PPF of country to and Ais is ppp of county F + We have assumed country 't Good -A PPE is flatter than country 'H' which implies that the alternative cast of Good A interms of Good B is lower in Country it than in Country is co) factor prices of labour and capital are 'W' and 'r Good A poice = Pa Good B price = Pb pre-trade relative price ratio of good A in Country H - price poice of of good A good B & Po Pb

I pre trade relative price ratio of good and Hin country it Pa Country H I unit of x = Pb Pa unit of y Country of 1 unit of x= Pa unit of y. Pь