Assignment:
1. Neoclassical Model (cont):
(a) Draw a graph of a country in autarky that is fully utilizing its resources but not maximizing its utility. In the maximize its utility. Also, describe the mathematical logic of this change using the MRS and MRT in your explanation.
(b) Now assume that this country opens up to trade and discovers that it has a comparative advantage in the good located in the x-axis of your graph. To what extent should it specialize in the production of the good to be exported? Again, explain the mathematical logic.
(c) How and why would your answer to part (b) be different under the assumptions of the Classical Ricardian model?
(d) Draw a fully labeled graph showing the autarky equilibrium, the degree of specialization, the consumption possibility frontier, the optimal consumption bundle, the utility gain from trading, and the quantity of exports and imports.
2. The Specific Factors Model: Suppose there are only two types of goods being produced in Peru: Vegetables and Plastic Cups. Suppose the Vegetables are produced with labor and land while the Plastic Cups are produced with labor and capital. Labor is the only factor of production that is mobile between industries. Suppose that Peru has a comparative advantage in the production of Plastic Cups.
(a) If Peru opens its economy to trade, what will happen to its domestic production level and the price of Plastic Cups relative to Vegetables? (Briefly explain)
(b) What will happen to the nominal wage rate of all workers in Peru? Show what happens with a dual labor market graph.
(c) Using the graph in part (b) indicate how much the wage rate changed relative to the price.
(d) Can we conclude that workers are better-off as a result of Peru opening itself up to trade? (briefly explain).
(e) Who are the clear winners and losers when Peru opens itself to trade?