Question

1. Welfare in the Standard Model

Belgium and China can produce industrial equipment and textiles. Suppose that China

has a comparative advantage in textiles while Belgium has a comparative advantage in

industrial equipment.

a. If the underlying source of comparative advantage comes from specific factors, what

assumptions on technology and endowments would lead to each country’s comparative

advantage? (5 pts)

b. Draw production possibilities frontiers for Belgium and China consistent with their advantages with industrial equipment on the y-axis. (10 pts)

c. Use the production possibilities frontier for China and an isovalue line to show

production in China under Autarky. In a second diagram show the corresponding point on

China’s relative supply curve. (15 pts)

d. If China opens to trade, does industrial equipment or textiles become relatively more

expensive for China? With industrial equipment on the y-axis, does the isovalue line

become steeper or shallower? Using the same two diagrams, show China’s production

under trade and their new relative supply at the new world relative price. (15 pts)

e. In a new graph, show a trade equilibrium for China and Belgium consistent with their

comparative advantages. Your graph should have two diagrams (one for Belgium and one

for China) and depict the allocation of consumption and production for both countries.

(15 pts)

f. Suppose that the world price for industrial equipment rises. Do the terms from trade

for Belgium increase or decrease? Do the terms from trade for China increase or

decrease? (10 pts)

g. On the same graph from part e, show the new allocation or production and

consumption for both countries at the new relative prices. Does welfare increase or

decrease for each country and why? (10 pts)

Answer 1