Question

Consider the Ricardian model with two countries, Home and Foreign, and 2 goods, cloth and widgets....

Consider the Ricardian model with two countries, Home and Foreign, and 2 goods, cloth and widgets.
Based on the information below, answer questions 7 through 10:

Marginal Product of Labour

Cloth Widgets Total endowment of Labour (L)
Home 10 15 200
Foreign 10 30 100

7. Suppose the world relative demand for cloth is given by (C/W) = 3 - (pC/pW) where C denotes clothes
and W widgets. The equilibrium relative price of cloth with trade will then be:
A. 9/2
B. 7/3
C. 8/3
D. 2
E. we cannot tell

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Answer #1

Since home can produce 2000 units of cloth or 3000 units of widgets, the opportunity cost of cloth is 1.5 units of widgets. The same for foreign is 3 units of widgets so Home has comparative advantage in cloth. The trade price lines between opportunity costs and so the range is 1.5 to 3 units of widgets.

Relative supply is vertical at Q* = (Lhome/unit labor requirement in clothes at home)/ (Lforeign/unit labor requirement in widgets at home) = (200/0.1)/(100/0.0333)) = 2/3

Relative demand is 3 -relative price

3 - relative price = relative supply = 2/3

Hence relative price is 3 - 2/3 = 7/3

Option B is correct.

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