Imagine that you are advising a small country on the short run effects of opening up to trade.

Use the specific factor model to conduct your analysis. Policymakers in a country are interested in who

in the country will gain and who will lose from trade. They are also interested in the overall welfare

effects of trade. Assume that there are three factors of production: low-skilled workers, high-skilled

workers and capital. Moreover, assume that there is a low-tech and a high-tech good. Capital is used

to produce both goods but high-skilled workers are specific to the high-tech good and low skilled

workers are specific to the low-tech good.

a) Describe using a graph how the allocation of capital is determined (i.e. how much capital is allocated

to each sector). (1 Marks)

b) Assume now that the relative price of high-tech goods in terms of low-tech goods is lower in this

country than in the rest of the world. What does this say about the relative endowments in the country

of low-skilled and high-skilled workers compared to the rest of the world? (1 Marks)

c) What does the model say about how trade affects overall welfare in the country? Use a graph to

explain. (1 Marks)

d) Is it possible to make sure that everyone gains from trade? If so, how? (1 Marks)