Question

1. When Home has comparative advantage over Foreign in cloth,

A. The Autarky relative price of cloth in terms of wine is lower at Home than in Foreign

B. Foreign must have comparative advantage over Home in wine

C.Home will specialize in producing cloth when there is free trade

D. Both (A) and (B) are correct

E. (A), (B), and (C) are correct.

2. In the Ricardian Model, with countries Home and Foreign and with two goods under trade, assume aLC/ aLW <a°LC/ a°LW where aLC and aLW are unit labor requirements for cloth and wine in Home and a°LC and a°LW in Foreign. Suppose a Home-export biased catch-up occurs in Foreign, i.e. a°LC decreases. Then it is the case that:

A The relative price of cloth (vs. food) may go down.

B The terms of trade of Foreign must improve

C The terms of trade of Home may remain unchanged.

D (A) and (C)

E None of the above

Answer 1

1) The correct answer to this question is "E". Both option A and option B and C are correct. When the home has a comparative advantage over foreign in cloth the Autarky price of cloth will be lower at home and home will specialize in the production of cloth. Foreign will have a comparative advantage in wine.

2) An export bias reduces the countries term of trade and increases the welfare in the foreign country i.e. the importing country harming the welfare of exporting country. The correct answer to this question is "A" THe relative price of cloth may go down.