Explain how is the production structure (i.e. which goods are produced) affected in each country by opening up to trade. Is this consistent with the empirical evidence we observe in reality? How can this model be modified to produce a less stark result?
Consider a world composed of two countries, Home (H) and Foreign (F). Individuals living in each country
i = H, F have preferences over two goods x and y.
In each country there is only one factor of production, labour, which is perfectly mobile between industries but
immobile between countries. The total labour endowment at Home is LH = 10 and the total labour endowment
in Foreign is LF = 10.
The marginal product of labour in each industry is constant. At Home, one worker can produce 2 units of
good x or 1 unit of good y per unit of time; at Foreign one worker can produce 1 unit of good x or 2 units of good
y per unit of time.
Assume that consumers in Home and Foreign always consume goods x and y in the same quantity regardless
of their prices. That is, Cxi = Cyi, i = H, F
G. Explain how is the production structure (i.e. which goods are produced) affected in each country by opening
up to trade. Is this consistent with the empirical evidence we observe in reality? How can this model be
modified to produce a less stark result?
H. Suppose you conduct an opinion poll among individuals at Home, in which you ask them whether they have
benefitted from international trade. What do you predict the response would be? Is this consistent with the
empirical evidence we observe about people’s support for free trade in reality?
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