2. Suppose a small country produces product A and B with K and L. In free trade, it produces the quantities A0 and B0 as illustrated in Fig.1 by the two bold isoquants. We also know that it exports product B to the rest of the world.

(i) Illustrate the free-trade equilibrium with a Production Possibility curve and Community Indifference Curves. Make sure to label the axes and to identify production and consumption.

(ii) What can we say about w r in this country in free trade and in autarky with respect to the rest of the world? Explain as precisely as possible.

(iii) Suppose there is a technological change in industry B such that both factors of production when employed in that industry are more productive. As a result, in order to produce the quantity B0 there is less need to use both K and L as illustrated in Fig 1 by the dotted isoquant labelled B0. What happens to the production possibility frontier in that country? Explain and illustrate.

(iv) What happens to the volume of trade between this country and the rest of the world as the result of this technological change? Explain and illustrate.

(v) What happens to w r in that country as a result of the technological change? Explain as precisely as possible.

(vi) What would be different if the country, instead of being small, was a large country with respect to the rest of the world? Explain.