Assume that increasing costs prevail in both Russia and Latvia. Russia is a labor abundant country...

Assume that increasing costs prevail in both Russia and Latvia. Russia is a labor abundant country compared to Latvia; and Latvia is a capital abundant country compared to Russia. Vodka, which is produced in both countries, is a labor-intensive product; and computer, which is also produced in both countries, is a capital-intensive product.

(a) Draw the production possibility frontiers of both countries. Identify the autarky prices and the trade triangles under normal conditions when they engage in free trade. Make sure you label all lines and curves in your graphs.

(b) Suppose the domestic demand for vodka increases in Russia (a reasonable assumption!) – so much so that the autarky price of vodka in Russia is higher than the autarky price of vodka in Latvia. How does this change your analysis? Explain with graphs.

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Expert Solution

Rahul Sunny answered 1 year ago

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