Question

1. Consider a world with two countries trading Clothing and Food. Assume one country (US) has comparative advantage in Clothing and exports it in the world trade equilibrium. Suppose world tastes for clothes then increase so rises.
   1. Does the ratio of the labor wage in US to the labor wage in Foreign w/w^∗ increase, decrease, or is the change ambiguous in each of the following models when p^T_C/p^T_F rises? Explain your answers.
      1. The Ricardian model in the case where both countries are fully specialized in the good inwhich they have comparative advantage?
      2. The Hecksher-Ohlin model in the case where both countries have the same technologies andboth countries produce both goods?

(b) Suppose all factors in each country are owned by a single representative person in each country. How does welfare of the representative person in Home change relative to welfare of the representative person in Foreign when p^T_C/p^T_F increases, in each of the cases mentioned above?

Answer 1

There are two countries trading clothing and food. Suppose the good are produced using two factors of production Capital and labor. US has comparative advantage in production of clothing. Suppose Clothing production is capital intensive (requires more units of capital than labor to produce one unit of clothing) and Food production is labour intensive (requires more units of labor than capital to produce one unit of food).

a. i. In a Ricardian model the country having comparative advantage in a particular good produces only that good. Here, US has comparative advantage in production of Clothing so in a Ricardian Model US will produce only clothing so, the factors of production that was used in food production will now be used in clothing production and as laborers are less efficient in production of clothing there wage will fall. Hence, the ratio of labor wage in US to the labor wage in Foreign w/w* will fall because w falls and w* increases because the other country is producing food and the efficiency of laborers are higher in food production so w* rises hence w/w* will fall.

ii. In a Heckscher-Ohlin Model both countries produces some of both goods but it produces more clothing becuase it has comparative advantage in production of clothing. The income of the factor used relatively intensely in the production of the good in which US has comparative advantage is higher so the rent is higher than the wages. So, under Heckscher- Ohlin model also w/w* falls.

b. When the relative price of clothing increases that is when P^TC/P^TF increases the country producing more clothing receives a higher price.

In a Ricardian Model if a single representative person owns all the factors of production his welfare will be more than the representative person in foreign country because the relative price of clothing is higher and hence the returns to clothing is also higher ans in Ricardian model as US produces only clothing all the welfare gain due to relative price rise is enjoyed by the single representative individual.

In a Heckscher- Ohlin model the country produces both goods so the factors employed in clothing production earns more while that in food production earns less. The welfare of the single representative person owning all factors of production is also higher than that in Foreign but the welfare is less than the Ricardian model because here both the goods are produced and the returns from factors employed in clothing earns more while those employed in food production earns less but as US has comparative advantage in clothing production it produces more clothing so the welfare is more than the foreign single representative person.