International Trading

1. Two countries, Home and Foreign, both produce cheese and wine. The number of hours it takes for the countries to produce one unit of either good is presented in the table below
Home country Foreign country
a cheese 2 hours 3 hours
a wine 1/2 hours 2 hours
where a cheese and a wine are the unit labour requirements in the production of cheese and wine, respectively. Assume that both countries have the same set of standard homothetic indifference curves (i.e. the same tastes).
1.1. Which country has a comparative advantage in the production of cheese? Which country has a comparative advantage in the production of wine? Explain your answer thoroughly. (1 points)
1.2. Assume the Home country and the Foreign country have a labour supply of 6 and 12 hours, respectively each.
Figure 1.2 below depicts the PPFs, and the equilibrium points (A and A*) of the Home country and the Foreign country in autarky. Do both countries maximize their welfare (utility) in autarky? Explain your answer thoroughly. (1 points)
Figure 1.2.
1.3. Note that point E (QWine=6 & QCheese=3) on Figure 1.3. is the equilibrium consumption point of Home country after trade with the Foreign country. Graphically draw and explain the Consumption Possibility Frontier of the Home country after trade and the indifference curve
associated with the highest level of utility that it can reach after trade. Explain your answer thoroughly. (3 points)
Figure 1.3.
1.4. Given the information on Figure 1.3. What can you say about the trade patterns? Specifically, what is the world price of cheese after trade? What is the consumption of the Foreign country after trade? Locate and show the consumption point of the Foreign country after trade on the Figure 1.3. What is the value of exports of Home and Foreign countries? Explain why both countries gain from trade! (3 points)
1.5. Can point F on Figure 1.4. be the consumption equilibrium point after trade? Explain your answer thoroughly. (2 points)

Two countries, Italy and France, produce two goods, food and television. Italy is land abundant and France is capital abundant. Food is produced using land intensive production methods, while television production is capital intensive. Assume both countries have identical tastes and technologies.
2.1. Use production possibility frontiers and community indifference curves for both countries to illustrate and explain how the domestic price is determined in the absence of trade. Which country has a lower relative price of food in autarky and why? (3 points)
2.2. Redraw your diagrams from part (a) to illustrate and explain what happens to quantities of both goods produced in both countries before trade when Italy becomes less land abundant and France more capital abundant and when we assume that there is no change in the relative price of food in both countries. (3 points)
2.3. Suppose that trade now occurs between the two countries. What impact does trade have on the real income of the owners of capital and land in both countries? Explain thoroughly (Hint: to answer this question use what you know about the relationship between output relative price, the ratio of land rental rate to capital rental rate and the capital-land ratio used in the production of both goods). (4 points).


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