Question

	Mexico	United States
Bottles of Tequila produced per hour	15	4
Pounds of Rice produced per hour	4	6

(a) Determine the pre-trade relative price of tequila in Mexico and the United States.

(b) Given your answer in part (a), which country has a comparative advantage in the production of rice?

(c) What is the lowest international relative price of tequila Mexico is willing to accept in order to engage in trade with the United States? Explain why.

Now suppose that as a result of international migration policy, the number of laborers in the United States expands to 200 while the number of laborers in Mexico decreases to 3

(d) What is the range of possible terms of trade for the United States? Which end of the range do you think the terms of trade will be closer to?

(e) Which country do you expect gains more from trade? Briefly explain why.

Answer 1

(a) Pre-trade relative price of tequila in Mexico : P_T/ P_R = MPL_R /MPL_T = 4/15 = 0.27

For U.S = P_T/ P_R = MPL_R /MPL_T = 6/4 = 1.5

(b) Because Mexico has th lower pre trade relative price of tequila , therefore, Mexico has the comparative advantage in the production of Tequila.

And U.S has the comparative advantage in the production of Rice.

(c) The lowest international relative price of tequila Mexico is willing to accept in order to engage in trade with U.S is must be atleast 4/15. Because Mexico's pre trade relative price of tequila is 4/15.

Number of laborers in the U.S expands to 200 while the laborers in Mexico decreases to 3.

(d) U.S terms of trade = P_R /P_T . Because U.S exports rice.

Mexico :pre trade relative price of rice = P_R/ P_T=15/4 = 3.75

U.S: Pre trade relative price of rice =P_R/P_T = 4/6 = 0.67

Range of possible terms of trade for U.S is (0.67 to 3.75).

(e)Given the relative size of the two countries , the world relative price will be closer to the no-trade relative price of tequilla in the U.S , so that Mexico gains more from trade.