Question 2

Assume that the world consists of the European Union (EU) and China and that consumers only consume cauliflowers and turnips. Production of cauliflower in the EU is 0,25 units per labour hour while output of turnip per hour is 0,50 units. China can produce 0,20 cauliflower per hour and 0,08 turnips per hour. For simplicity, EU and China both have a labour force of 250.

(a) Draw the Production Possibility Frontiers (PPFs) for both countries, where you measure cauliflower on the horizontal axis and turnips on the vertical axis.

(b) What will the relative price of cauliflower be in the two countries under autarky?

(c) What are the real wages in the two countries?

(d) Assume that the two countries start trading with each other and abolish all tariffs. Within what interval must the free trade relative price of cauliflowers lie? Describe the international pattern of trade.

(e) Assume that the international relative price of cauliflowers is 1.

Are there gains from trade for the EU and China? If you like, show this in the figure you made in a).

(f) What are the real wages under free trade in this case?

(g) Assume that China experiences rapid productivity growth in the turnip sector so that production increases to 0,40units per labour hour. How does this affect gains from trade between China and the EU?

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