International trade

Answer TWO out of THREE questions 1. Consider two islands, Isla de Pascua and Gressholmen, both with an endowment of 9 Easter eggs and 9 Easter bunnies. Suppose that the preferences of the inhabitants of either island can be represented by U(Xe, b) = xx7 , where we and x are the quantities consumed of Easter eggs and Easter bunnies respectively, and a equals 2/3 on Isla de Pascua and a = 1/3 on Gressholmen. (a) (30 points) Find the autarky equilibrium ( relative) price on each island. Explain what pattern of trade you expect to see as soon as both islands engage in free trade. (b) (30 points) Find the free trade equilibrium, i.e. the equilibrium ( relative) price and the quantities traded. Show that there are gains from trade. (c) (40 points) Suppose the endowments were slightly different, namely 93 eggs on Isla de Pascua (still 9 bunnies), and 93 bunnies on Gressholmen (still 9 eggs). Find the value of B (if any) for which they do not trade. What does this tell you about the interaction between Heckscher- Ohlin style endowment differences and demand differences