Question

In order to conjecture the circumstances in these two countries under autarky

(when there is no trade), consider the following hypothetical scenario based on

Ricardian model. Assume throughout that those two countries (Argentina and

El Salvador) are the only two countries in the world, at least for purposes of

trade. There are two goods: Hammers and Widgets. Consumers in both

countries always spend half of their income on Hammers and half of their

income on Widgets. The only factor of production is labour. Each Argentinian

worker can produce 4 Hammers or 2 Widget per unit of time. Each El

Salvadoran worker can produce 2 Hammers or 2 Widgets per unit of time.

There are 50 workers in Argentina and 75 workers in El Salvador. You need to

provide conditions in each country by stating:

a) Derive the relative demand curve relating the relative demand for Widgets

to the relative price of Widgets. Do this algebraically, and then show what

the curve looks like in a diagram (put the relative price of Widgets on the

vertical axis and the relative quantity of Widgets demanded on the

horizontal axis).

b) Derive the world relative supply curve of Widgets (put the relative price of

Widgets on the vertical axis and the relative quantity of Widgets supplied

on the horizontal axis).

c) Put in the same figure the relative demand curve for Widgets that you found

in part (a) and the world relative supply curve of Widgets that you found in

part (b). Determine the equilibrium relative price of Widgets and the

equilibrium relative quantity of Widgets under free trade.

d) Under free trade, which country produces which good(s)? How many

units?

e) Who gains from trade? Who loses from trade? State workers’ stance

towards free trade in each country, i.e., do they support or oppose free

trade?

Answer 1