Assume a Ricardian model with two countries, Home and Foreign, that both produce coffee and tea....

Assume a Ricardian model with two countries, Home and Foreign, that both produce coffee and tea. Home has 600 units of labor (L) available. Home’s unit labor requirement in the production of coffee is a_LC = 4, while in the production of tea it is a_LT = 3. Foreign has 800 units of labor (L^*) available. Foreign’s unit labor requirement in the production of coffee is a^*_LC = 2, while in the production of tea it is a^*_LT = 1.

a) Assume there is no trade. Moreover, markets are competitive and wages equal marginal productivities.

a1) Determine Home’s production possibility frontier (PPF), i.e., denote Q_C as a function of Q_T where Q_C denotes the output of coffee and Q_T denotes the output of tea.

a2) Determine the wages that are paid in both sectors in Home. Provide a brief explanation.

a3) What are the equilibrium relative prices of coffee in terms of tea in both countries? Provide a brief explanation.

b) Assume now that there is free trade.

b1) Assume the world relative price of coffee in terms of tea is P^T_C / P^T_T= 1.5. Determine the production output of coffee and tea for both countries. Explain how you get to your results.

b2) Assume the world relative price of coffee in terms of tea increases to P^T_C / P^T_T = 2. How does your answer to part b1) change? Briefly explain.

Expert Solution

Rahul Sunny answered 7 months ago

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