Question

Consider the following model of trade between Home and Foreign. Assume throughout that those two countries are the only two countries in the world, at least for purposes of trade. There are two goods: Corn and Radio. Consumers always spend one-third of their income on Corn and the remainder on Radios. The only factor of production is labour. Each home country worker can produce 2 units of Corn or 3 units of Radios per unit of time, while each foreign worker can produce 2 units of Corn or 4 units of Radios per unit of time. There are 30 workers in Home and 60 workers in Foreign.

(a) Derive the relative demand curve relating the relative demand for Radios to the relative price of Radios. Do this algebraically, and then show what the curve looks like in a diagram (put the relative price of Radios on the vertical axis and the relative quantity of Radios demanded on the horizontal axis).

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

(e) Who gains from trade? Who loses from trade? State labours’ stance towards free trade in each country.

Answer 1