Ricardo Model: The problems below require the use of the following information. There are two countries H (Home) and F (Foreign) that can produce two goods, coffee and donuts. The following data describes the endowment and technologies:
|
αcoffee |
αdonuts |
L |
| H |
2 |
1 |
100 |
| F |
3 |
2 |
200 |
1. Show the PPF-Budget Constraint-Indifference curve diagram for H and for F in an autarky (no-trade) equilibrium. Label the intercepts of the PPF and Budget Constraint for each country and indicate the price of coffee in terms of donuts (provide numbers). Consider an international equilibrium with free trade between H and F. Suppose that in this free trade equilibrium that all the gains from trade go to H.
2. Show the PPF-Budget Constraint-Indifference curve diagram for H and for F in this free trade equilibrium. Make sure to label the intercepts of the PPF and Budget Constraint for each country and indicate the price of coffee in terms of donuts (provide numbers). Also indicate the difference between the production and consumption levels in H & F (no need for numbers). Explain how your diagrams show only H gains from trade.
3. Show the relative supply - relative demand diagram depicting the international equilibrium for the information above. Provide numbers where you can. The next two problems ask you to analyze how technology shocks change the equilibrium that you analyzed in questions 2 and 3.
4. Suppose that the marginal product of labor in H for both goods doubles. Show how this shock affects the welfare of consumers in F. Cover the range of possible outcomes (but no need for numbers). Use the relative supply - relative demand diagram in your answer.
5. Suppose that a natural disaster in H lowers the marginal product of H labor in coffee to 1/4 from 1/2 (i.e. increases αHcoffee from 2 to 4).
How does this shock affect welfare in H relative to the initial free trade equilibrium? Explain.