Consider a world economy consisting of two countries, Canada (C) and the US (U). The two demand and supply functions for the aggregate consumption good are

DC = 100p , SC = p ,

DU = 3804p ,SU = 6p.

(a) What is the equilibrium price and quantity in each country if there is no trade?

(b) Now the two countries sign a free-trade agreement. What is the new common price? What is the quantity consumed in Canada? What is the quantity produced in Canada?

(c) What are the changes in surplus to Canadian consumers and producers? What do you think happens in the US? Will overall surplus increase or decline?

(d) Now suppose that Canada collects a tari of $6 per unit of imported goods. What is the new price in the US? What is the price in Canada?

(e) How much are Canadian producers willing to pay to enact these taris?

California is very fertile. Farmers can produce avocados and corn on their land, 6 and 10 units per unit of land respectively. They have 5 units of land. In the Canadian prairies one can also grow avocados and corn, at 1 and 5 units per unit of land. There are 15 units of land. Assume both countries have perfectly competitive markets. Let the utility function of consumers in each country be U = A1=2C1=2. Demands are thus A = I=(2pA) and C = I (2pC).

(a) Who has the absolute advantage in producing avocados? Who has the absolute advantage in producing corn? Who has the comparative advantage in producing avocados? Who has the comparative advantage in producing corn?

(b) If California and Canada traded, then which goods would they trade in which direction?

(c) Let the price of corn be 1. For which range of prices for avocados would both countries produce avocados? For which range would only one country produce avocados? For which range would both countries produce corn?

(d) What is the total demand for avocados, if California only produces avocados and Canada only produces corn? What is the market price for avocados? Would farmers in each country want to change their production decision at this price?

(e) Canadian farmers have improved their farming techniques. Now they can produce 6 units of corn per unit of land. What is the impact on Californians: are they better or worse off?

(f) Now assume instead that Canadian farmers can grow avocados much better, they produce 5 units per unit of land. What does the new market price for avocados have to be if Canadians produce both avocados and corn? What will Californian farmers produce then? How much

corn will Canadian farmers produce?

Rob has 10 coconuts and 5 bananas, whereas Wilson has 5 coconuts but 25 bananas. Rob's utility is U_r = CB and Wilson's utility is Uw = CB^1/2.

a) What are their initial indifference curves? What are their slopes? Is there potential for trade?

b)Rob otters Wilson 1 coconuts for 5 bananas (entire units). Should Wilson accept and would Rob benefit from the trade (if there is no possibility for other trades)?

c) Wilson is contemplating a more favorable counter-offer. Find an example of a trade that makes Wilson better off than in (b) and Rob at least as well off as in the initial situation (also in entire units).

d) What condition has to be true so that no more beneficial trades can take place?

e) Now Friday sets up a shop and offers to exchange pB coconuts against one banana. What exchange rate pB would Friday have to set so that he does not keep any bananas or coconuts (he does not care about either)?