2. Consider a world with a home country H and a foreign country F, consumption goods 0 and 1, and technologies that use capital and labor. The home conntry has endowments [ Ky, Ly ). and the foreign country has endowments { Kp. Ly ) of capital and labor. The production function for consumption good w {0,1} is FL{K, L). These production functions are inereasing and eoncave, and exhibit constant returns to scale. The soquants of Fy and F; are smooth and do not hit the axes. Any pair of soquants for Fy and Fy has one and only one intersection. Evervone everywhere has identical homothetic preferences. Write po for the world price of good w {0,1} and (v;, w;) for the prices of capital and labor in country je {H.F}. a. Suppose world prices (po. g ) are such that country j produces both goods. Construct the Lerner diagram assuming good 0 s the capital intensive good. Explain and (i) show how you can determine the factor prices (v, w;) from this dingram; (i) show how the factor endowments (K, L;) are allocated. b. Copy what you need from part a to show what happens to the factor prices (v, w;) in country when py increases. c. Copy what you need from part a to show what happens to output (, y,) in country when (i) first K goes down and (i) then Lj increases. From now on, assume (py.py) are equilibrium prices and that both countries produce hoth goods. Continue to assume good 0 is the capital intensive good. Assume Ky > Kp and Ly