Question

2. Suppose that Home and Foreign consumers have the same preferences over these two goods, and they are represented by the following utility function: U(Q ,Q ) = Q1/3Q2/3. cwcw a. Graph the consumer budget line of the Home country and add indifference curves to the figure. Find the amount of cheese and wine that people in Home country consume in the no-trade equilibrium? b. Graph the consumer budget line of the Foreign country and add indifference curves to the figure. Find the amount of cheese and wine that people in Foreign country consume in the no-trade equilibrium? 3. Now consider an integrated world in which these two countries are trading with each other without having any trade barriers. a. Graph the world relative supply of cheese? b. Suppose that the world relative demand for cheese is RD = 9pw/5pc, where pc and pw are the price of cheese and wine in the world market. What is the world relative price of cheese in equilibrium? c. Using Ricardo’s argument, show that trade is welfare improving in both countries.

Answer 1

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