International Trade

1 Standard Trade Model [80 points] This question will guide you through an example of a \"standard\" trade model. We will rst analyze the production and consumption \"blocks\" individually, and then we will think about the equilibrium. Note: Ileft some space below each question, so that you can print out this le and report all your answers in the space provided [only if you want to]. Production [25 points] The Home country is known for the production of Cupcakes and Flour. The following is the production possibility frontier (PPF) for the Home country: lCupcakes| O 6 | 14 18|26 32| | Flour |32 26|18 14|6 0 | 1. Draw the PPF for the country? What does the PPF represent? [Hint please remember to label your axis; put Cupcakes in the xaxis] [7 points] 2. Suppose the country wants to produce 10 Cupcakes and 24 units of Flour. Is this allocation attainable? Why? [5 points] 3. What is the slope of this PPF? How does it vary with the amount of Cupcakes produced? [8 points] 4. What is the MRT function in this economy, i.e., M RT(QC, Qp)? [5 points] Consumption [5 points] Now suppose that preferences of the Home consumers are given by: U = log Do + log DF 5. What is the MRS function of the Home country, i.e., MRS(Dc, DF)? [5 points] Autarky Equilibrium [25 points] 6. What condition(s) must hold in an Autarky Equilibrium (AE)? [10 points] 2 7. Using the AE condition, argue that the autarky price (p4) in the Home country is equal to pA = 1. [Note: for full marks, please show full derivations. However, if you got stuck somewhere, you can use this info to solve (some of) the next questions] [5 points] 8. What is the autarky consumption and production point? [Hint: For the country to maxi- mize revenues, the equilibrium production point must be on the PPF] [10 points]