HW_1_Q3_hints

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HW 1 ECON433 Question 3 part e) and part f) hints e) Now imagine that trade is established. What is the possible range for the wage in China relative to the wage in Europe? What would happen if the wage were to fall outside this range? Hints: We know that the relative price of silk under free-trade must lie between the autarky prices in both countries. That is, between 0.5 and 20. We also know that Chinese exports will produce silk. You then need to find out the range of real wage for Chinese workers in terms of food. Now, you can discuss what if the relative price of silk below 0.5 (which would mean that the real wage in China would be below 0.5 units of food),or what would happen if the real wage in China is above 20 units of food. f) Explain what should be the equilibrium relative price of silk. At this international price, draw the CPF of both countries and determine the new equilibrium consumption and production point for both countries. Describe the pattern of specialization and trade. Draw the trade triangles. Talk

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Unformatted text preview: about the gains from trade for both countries. What happened to the wage in China in terms of silk, and in terms of food? Hints: First of all, you can derive the demand for food and silk in each country (for a given vector of prices and income). Since the goods are perfect complements, we will have , so if we substitute this into the budget constraint , we have: , and the same expression would hold for China (remember that I is the country’s income, yet to be determined). Given this expressions, we can calculate the relative demand for silk The relative supply curve will look like a staircase, with the jump. This is the relative quantity of silk produced if Europe specializes in food (and produces 300 units of it) and China specializes in silk (and produces 200 units). We can then calculate the consumption for china. If you multiply and divide by , So you can see the enormous gains from trade that China experiences Similarly, you can find the consumption and production for Europe....
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