Ricardian Model

l. {Rieardian Model, Chapter 2] Consider a Ricardian model of comparative advantage. There are two countries, China and the US. Each country can produce two goods, shoes {5} and food {F}. Assume China has 600 workers and the US has 200 workers. Labor productivity in each country is: Labor Productivity by Country and Good m 5 shoestdar 4 shoe-side: Is mam some... a)Which country has the absolute advantage in shoes?; in food? Explain. i What is the opportunity cost of' producing food in China?; in the U.S.? IWhat is the oppommity cost of producing shoes in China?; in the U.S.? b} Derive and sketch the production possibility frontier for each country. Assume that, prior to trade, the U.S. produces 500 shoes and 1,500 bushels of food, while China produces 1,200 shoes and 1,200 bushels of food. Show how it is possible, by altering production in each country. to increase total world output of both goods. c} In the absence of trade, what would autarlty {no trade} relative prices be in each country? What would the real wage (in terms of each good] he in each country? d} If trade is allowed between the two countries, what will the pattern of trade be (i.e., what good will the US export and what good will it import), how does trade affect the real wage in each country and what can you conclude about the postvtrade relative price of shoes? e} Assume all people have the same preferences. Let DP Direpresent demand for goods F [food] and 5 (shoes), respectively. Assume people spend one-half their income on each good: Df=( IfZPI); Di: ( HER) where I (personal income} is the wage rate, and P3 , PJIr are the prices of the two goods. Total income (its for US and ICU\" for China] is the wage rate times the number of workers (Hint: use total income to compute a country's total demand and start by assuming countries completely specialize. Is complete specialization by both countries an equilibrium? Explain your answer.}. i Find the equilibrium world {relative} price of goods under free trade [i.e., set total world supply equal to total world demand and solve for price}. ii Show how the real wage changes in each country due to free trade. Do both countries gain from free trade? 1'] Under free trade, how would a 15% increase in China's productivity in both sectors affect world prices and the real wage in the US and China? Explain. [a specic answer is required; use the demand curves from part [e] to find the new equilibrium relative price of shoes. Hint: start again by assuming that each country completely specializes. Is complete specialization still an equilibrium? Explain}