B.

Hecksher-Ohlin Model

Countries 1 and 2 each make steel and corn. The two countries have identical preferences and technologies, using only labor and corn as inputs. Steel manufacturing uses capital intensively. Country 2 is relatively capital abundant. a) Draw a carefully labeled diagram showing possible PPFs for the two countries. How would PPF look for one country if there were increasing returns to production of each of the two goods? For the rest of the question, assume that there are no increasing returns. b) For one of the countries, in the absence of trade, show graphically the marginal rate of transformation and marginal rate of substitution. Intuitively, why should the MRT=MRS in equilibrium? c) If trade is opened between the countries, what will happen to the relative price of steel in country 1? Explain and provide intuition. What if there are transportation costs? d) What effect will opening trade have on the returns to capital in country 2, with zero transport costs? Explain your answer and provide intuition. e) Suppose that transportation costs make trade impossible, but that labor migration is opened up between the two countries. Which way would you expect labor to flow? What will be the expected effect on returns to capital in the two countries? Explain briefly