Let us assume a 2x2x2 model (country H & F, good A & B, factors L & K).

The two countries are identical except L < L* and K > K*

More over good A is labor intensive and good B is capital intensive.

(a) Draw the PPFs of the two countries. (You need to measure A on the horizontal axis).

(b) Using factor prices w & r, commodity prices Pa & Pb, derive the relation between the pre trade relative price ratios of good A in H and F. (Correct version: Suppose the relative demand for A is identical in both countries. Using indifference curves for preference, derive the autarky relative price of A in H and F. Using appropriate diagram show the autarky factor price ratio in H and F)) Show the autarky prices using a graph with world relative supply and relative demands and show the direction of trade.

(c) For country F, using iso-quants and iso-costs, show that due to trade between H and F the factor that has been used intensively in the export sector will gain and the factor that has been used intensively in the import sector will lose.

(d) Now suppose the relative demand for good A (Rd) is NOT identical in H and F. Rather at each relative world price of good A, the H country's relative demand for good A (Rd) is way smaller than that of country F. In this case show the autarky prices using a graph with world relative supply and relative demands and show the direction of trade.