Question

Imagine an economy makes only clothes (QC) and food (QF) and has two inputs of production:...

Imagine an economy makes only clothes (QC) and food (QF) and has two inputs of production: Labor (L) and Capital (K). It takes 4 units of capital and 1 unit of labor to make one unit of clothing. It takes 1 unit of capital and 1 unit of labor to make one unit of food. There is no substitutability between the two inputs.

Hint: the total cost of production, TC, is equal to the wL+rK. You can think of L and K in this context as the number of units of Labor or Capital that it takes to make one unit of the good.

a. Write down the unit cost of production for one unit of clothing and one unit of food as a function of the wage (w) and rental rate (R). In a competitive market, those costs will be equal to the prices of clothing (PC) and food (PF), so write equations that set the price of the good equal to the cost of producing it.

b. Use the two equations in part (a) to solve for equations for w and R in terms of PC and PF(hint: you have two equations and two unknowns. This will take some algebra).

c. Before trade, the no-trade prices are Pc=$35 and PF=$20. Calculate w and R.

d. When trade opens, Home exports QC and the world prices are Pc=$39 and PF=$15. Calculate w and R again under the world prices. Compare them to what you found in part (c). How is this consistent with the Heckscher- Ohlin Model?

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