Question 2 - Specific Factors Model of Trade

Assume France can produce 2 goods Airplanes and Wine using labour (L) that is mobile between the 2 sectors.Capital machinery (K) is specific to producing airplanes.Vineyards (V) are specific to producing wine.

a.Use a single diagram to show how French labour (L) is allocated between airplanes and wine. This is the combined graph with the wage curves for each sector. Hint: The graph should represent both wages which are a function of MPL and prices.

b.What conditions must be met for the labour allocation to be a stable equilibrium, i.e., that both products are produced while France remains in autarky? Clearly identify the equilibrium in the diagram.

Now assume France engages in free trade and in the world market the price of wine is 10% lower than in France, while the price of airplanes does not change.

c.Redraw the diagram in point (a) and let the price of wine fall by 10%.

d.What happens to the labour demand curves in the airplane sector and in the wine sector?

e.What happens to the allocation of labour and why?

f.Who wins and who loses in France after opening to trade? Briefly explain.

Question 3 - The Heckscher-Ohlin Model of Trade

Assume two economies Germany (GER) and Cambodia (CAM) produce cars (C) and rice (R) using two factors, capital (K) and labour (L), which are mobile across sectors.Cars production is capital intensive and rice production is labour intensive. Further, Germany has 120 units of labour and 120 units of capital, while Cambodia has 100 units of labour and 80 units of capital. The cost of labour is w. The cost of capital is r.

a.Which country is capital abundant relative to the other country? Explain why.

b.In the diagram below, draw the relative supply of cars/rice for each country in autarky. Explain any difference across countries. (Hint: Remember that relative prices reflect opportunity costs).