Consider the following Ricardian model.
Marginal Productivity of Labor Labor Force
Butter Guns
Home MPL_b=1 MPL_g=2 L=150
Foreign MPL_b^*=4 MPL_g^*=3 L^*=100
(1) Draw the PPF for the Home country. Label the slope of the PPF and the maximum outputs of butter and guns.
(2) Which country has the comparative advantage in butter? Why?
(3) If Home and Foreign engage in free trade, then in the free-trade equilibrium, what is the range of the price of guns relative to the price of butter?
For questions (4)-(5), assume that under the free trade equilibrium,P_g^w/P_b^w=2/3; i.e. the price of guns is 2/3 of the price of butter.
(4) Calculate the real wage in terms of butter in the Foreign country.
(5) Show that the Home country gains from trade using the graph in (1).
Specific Factors Model (10 point)
1. Assume that in addition to the mobile factor of production (labor), there are two specific factors (drylands and wetlands) to produce two goods, cactus (C) and rice. Dryland is only productive in growing cactus and wetlands can only grow rice.
Suppose the world relative price of cactus is higher than the Home autarky price
(frac{P_C^W}{P_R^W}>frac{P_C}{P_R})
(1) With the aid of a diagram compare the autarky and trade equilibria for cactus and rice.
(2) With the aid of a diagram determine the effect of this price increase on the allocation of labor (L_C and L_R).
(3) Determine the effect of this price increase on the real returns on dryland and wetland, respectively.
(Hint: how do changes in L_Cand L_R affect marginal product of land?)