RICARDIAN TRADE MODEL

Assume 2 outputs, X and Y, two countries, A and B, and one input, Labor. The production functions for countries A and B are given by:

Country A: X = 1/16L_X and Y = 12L_Y

Country B: X = LX and Y = LY

Country A's labor endowment is L = 160 and B's is L=40.

a. Graph each country's PPF below. What is the economic interpretation of the slope of the PPF (with X on the horizontal axis)? How would you interpret the slope in terms of MCX and MCY? ...in terms of the labor requirement coefficients?

b. Fill in the table below. Based on the information above, how does the increase in the world price of X affect workers in A and B, andwhat is the "intuition" behind this result?

	Real wage before trade in terms of each good	Real wage after trade at a world of (Px/Py) = 3Y per X in terms of each good	Real wage after trade at a world of (Px/Py) = 3.5Y per X in terms of each good
Country A	In terms of Y: In terms of X:	In terms of Y: In terms of X:	In terms of Y: In terms of X:
Country B	In terms of Y: In terms of X:	In terms of Y: In terms of X:	In terms of Y: In terms of X

c. Suppose under the trade scenario the world price of X is equal to 3Y per X. Suppose the money prices of X and Y are Px = $3 per X and Py = $1 per Y. Calculate each country's money wage at these international prices. Using these money wage rates, explain why the money marginal cost values (MCX and MCY) will be such that one country will have a lower MCx than that other but that it will be the reverse for MCy. Show work.

W in country A = ________________________________________

W in country B = ________________________________________

For A the MCx = ___________________ and for B the MCx = ___________________

For A the MCy = ___________________ and for B the MCy = ___________________

d. Assuming the relative price of X is between the opportunity costs of each country, then explain what this implies about the ratio of money wage rates. What does this, in turn, imply money MC of X in each country and the money MC of Y in each country.

Based on your answers above, evaluate the following statement:" If a country has a higher nominal (money) wage rate than another country then it must also have a higher money marginal cost."

e. Explain how the distribution of the gains from trade are determined by which section of the world supply curve the world demand curve crosses. (Consider only intersections along the vertical stretch). You should do so by using graphs of the PPF and CPF curves and assuming demand for X falls. Show also the market supply curve and individual supply curves for each country.