In the context of the Heckscher-Ohlin model of trade, consider a small open economy (SOE) that produces two goods, X and Y, that each requires labour, L, and capital, K. Assume that X is labour intensive, and Y is capital intensive. Assume the world price ratio is greater than the autarky price ratio,(Px/Py)*>(Px/Py)A.The country chooses to impose an export subsidy on X.

a) Draw the general equilibrium trade diagram to represent the above case.

b) What are the effects of this policy on the welfare of the economy in question? How is this demonstrated in your diagram?

c) What are the welfare implications of the policy on labour versus capital? Justify your answer.

d) What are the effects of this policy on the volume of trade? How is this demonstrated in your diagram?