Suppose there are two countries: Sweetland and Vinegaryard; and there are two sectors in both countries: a tradable goods sector for manufacturing automobiles and a non-tradable goods sector for providing restaurant services. Vinegaryard has higher productivity in automobile manufacturing than Sweetland; while both countries have the same productivity in restaurant services. Relevant data have been collected as follows:

The price of a model of car is 10,000 and 50,000 in Vinegaryard and Sweetland respectively;

The wage rate in Vinegaryard is 10/wh, i.e., 10 per worker per hour worked, indicating the marginal product of labour is 0.001 car/wh, or one worker in one hour worked can make 0.001 cars;

The wage rate in Sweetland is 25/wh, indicating the marginal product of labour is 0.0005/wh;

The marginal product of labour is 1 dinner/wh in both Vinegaryard and Sweetland, i.e., one chef in one hour worked can prepare 1 dinner in both countries;

The economy of Vinegaryard consists of 50% of the tradable goods sector and 50% the non-tradable goods sector.

Required:

(a) What would be the exchange rate between and ? (4 marks)

(b) What is the ratio of the price and the price for a dinner? (4 marks)

(c) Estimate the extent to which the overall price level in Vinegaryard is higher or lower than what the exchange rate suggests. (6 marks)

(d) Discuss your results with reference to the Balassa-Samuelson hypothesis. (6 marks)