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Subject Code : ECO2ITR
Country : Australia
Assignment Task
 

SECTION 1
Question 1 – Ricardian Model of Trade
Suppose two economies Home (H) and Foreign (F) produce two goods, bread and wine, with only one production factor: labour. Production technology, expressed as marginal product of labour (MPL), is given in the following table:
Technologies expressed as MPL* Bread Wine
Home 1/3 1/6
Foreign 1/2 1
*Note that technologies are expressed as Marginal Products of Labour (MPL) not as unit labour requirements. To learn how these two measurements of labour productivity relate, please consult the material covered in class and the textbook.
Suppose that Home has 2400 units of labour and Foreign has 1800 units of labour.

- Derive the Production Possibilities Frontier (PPF) and the Consumption Possibility Frontier (CPF) for Home and Foreign, with bread on the horizontal axis and wine on the vertical axis. What is the autarky equilibrium price of bred relative to wine in each country?
- What country has the absolute advantage in producing each good? What country has the comparative advantage in producing each good? Briefly explain the difference between these two concepts.
- Suppose both countries are now free to trade. Draw a graph depicting the global market of bread and wine with the relative price of bread on the vertical access and the relative quantity of bread on the horizontal axis. Assume the relative demand curve (RD) is given and it intersects the relative supply curve (RS) at a relative price of bread of 1. Note that this is a point in between the two relative prices in autarky in each country.
- Now suppose these countries trade with each at the equilibrium relative world price of bread. What is the pattern of specialisation and trade? Why?
- To the graphs you drew in point (a) add the CPF after free trade. Which country gains from free trade according to Ricardian Model. Why?

Question 2 – Specific Factors Model of Trade
Assume Greece can produce 2 goods Appliances and Corn using unskilled labour (L) that is mobile between sectors. Capital (K) is specific to producing Appliances. Land (T) is specific to producing corn.
- Use a single diagram to show how Greek labour (L) is allocated between appliances and corn. This is the combined graph with the wage curves for each sector. Hint: The graph should represent both wages which are a function of MPL and prices.
- Describe the condition required for the labour allocation to reach a stable equilibrium. Clearly show the equilibrium in the diagram.
Now assume Greece engages in free trade and in the world market the price of corn is 20% lower than in Greece, while the price of appliances does not change.
- Redraw the diagram in point (a) and let the price of corn fall by 20%.
- What happens to the labour demand curves in the appliances sector and in the corn sector?
- What happens to equilibrium wages, the allocation of labour and why?
- Who wins and who loses in Greece after opening to trade? Briefly explain.

Question 3 – The Heckscher-Ohlin Model of Trade
Assume two countries Norway (NOR) and Turkey (TUR) produce Machines (M) and Food (F) using two factors, capital (K) and labour (L), which are mobile across sectors. Machines’ production is capital intensive and rice production is labour intensive. Further, Norway has 250 units of labour and 250 units of capital, while Turkey has 200 units of labour and 160 units of capital. The cost of labour is w. The cost of capital is r.
- Which country is capital abundant relative to the other country? Explain why.
- In the diagram below, draw the relative supply of machines/food for each country in autarky (approximate positions). Explain any difference across countries and identify the relative prices and quantities in equilibrium in each country in autarky. (Hint: Remember that relative prices reflect opportunity costs).

 

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