Consider two countries, Home (relatively land-abundant) and Foreign (relatively labor-abundant), that use labor (L) and land (T) to produce clothing (L- intensive) and food (T-intensive). Both factors freely move across sectors.

The production technology in each sector demonstrates constant returns to scale with diminishing returns of marginal product of each factor and factor complementarity. Consumers in this economy exhibit homothetic preferences.

W, Rdenote worker wages and rental rate of land respectively. Suppose that the two countries engage in free trade. Use diagrams and equations to justify your answers below.

(a)Which country exports clothing? Which country exports food?

(b)How does the wage rental ratioW/Rchange in Home?

(c)What happens to the land to labor ratio (T/L) in each sector in Home?

(d)Will the landowners in Home be in favor of imposing protectionist trade policies on Foreign imports? Describe how their real incomeR/P_CandR/P_Fchanges with trade.

Suppose Home experiences a drought that reduces Home's stock of arable land.

(e)Using the box diagram above, demonstrate the change in factor allocations before and after the drought.

(f)At a given world relative price (P_C/P_F)^W, what happens to the production of each good in Home? Draw a graph to illustrate changes and state a theorem that provides guidance for this analysis.

(g)Assuming that the pattern of trade does not change, show the effect of Home's drought on the world relative price, (P_C/P_F)^W.

Hint: Sketch and label the relative supply (RS) curves and the relative demand (RD) curves of Home, Foreign, and the World; and demonstrate the changes in these curves due to the drought. Put Q_C/Q_Fon the x-axis and P_C/P_Fon the y-axis.

Labor used in food OF Land used in food Land used in clothing Oc Labor used in clothing