International Economics

Question 2

Assume that Sweden and Denmark both produce the sweater x, and the pencil y. Both goods make use of the inputs capital (K) and labor (L), at given input prices r and w respectively. The sweater is labor intensive, and Denmark har a relatively large amount of labor.

(a) Formulate production functions for both countries.

(b) Compare the relative factor endowments in the two countries. Illustrate the two countries production possibilities frontier in the same diagram.

(c) Compare the relative price on sweaters between the countries and determine and draw the no-trade equilibrium. You can assume the preferences are identical in the two countries, and you can use the same diagram as in (b).