Problem 1. This question helps you review the Ricardian model.
MPL/Cloth MPL/Widgets Labor units/Cloth
Home 1/100 1/200 600
Foreign 1/60 1/30 120
Answer the following questions and show your steps. For the T/F questions, please explain why they are T/F.
(1). T/F? The Foreign country has the absolute advantage for both cloth and widgets.
(2). Draw the PPF for the Home country. Please label the max cloth output and max widget output.
(3). T/F? The Home country has the comparative advantage for widgets.
(4) T/F? In the Foreign country, under closed-economy equilibrium, 1 cloth fetches the same price as 2 widgets.
(5) Calculate the real wage for widgets in the Home country under closed economy equilibrium.
(6). If these two countries trade, then what is the lower limit of the relative price of cloth in the free-trade equilibrium (i.e. PclothT/PwidgetT)?
For the questions below, assume that PclothT/PwidgetT = 1.
(7). In your PPF picture in (2) above, illustrate that the Home country gains from trade. You may also draw a new picture below if you wish. Please label the slope of the CPF.
(8). Calculate the real wage for widgets in the Home country under the free-trade equilibrium.
(9) Calculate the wage of the Home country relative to the wage of the Foreign country under free trade.
(10) According to your answer to (9), which country has a higher wage under free trade? What is the intuition for this?
(11) T/F? Because the Home country gains from trade, the real wage for cloth under free trade is higher than under closed economy.
Problem 2. This question helps you get a deeper understanding of the wage equation.
(1) According to our wage equation, w = P x MPL. We also know that in competitive markets, price equals marginal cost. What is the expression for marginal cost, according to the wage equation?
(2) Explain, in plain English, why the expression you derive above is marginal cost.