Econ_181_HW1_S13_Solution

In open trade system the home country would

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Unformatted text preview: ) Pc/Pw aic/ aiw= 5/2 6/5 aic*/ aiw* = 6/6 = 1 2/3 6 (Qc/Qw)w = (Qc+Qc*)/(Qw+Qw*) 6 Here, we are faced with a linear relative demand function and homothetic preferences. In equilibrium: (Qc + Qc*)/(Qw + Qw*) = 6 – 5(Pc/Pw) = 2/3 à༎ Pc/Pw = 16/15 Also, in equilibrium, since the relative demand curves passes through the vertical part of the relative supply curve, we know that both countries specialize. While the foreign country specializes in the production of cheese, the home country specializes in the production of wine. So, Qc = 0; Qw = 100/2 = 50; Qc* = 200/6 = 33.3; Qw* = 0. Finally, we calculate the equilibrium wage rates. w = Pw/aiw = Pw/2 and w* = Pc/aic* = Pc/6 where Pw and Pc are world prices of wine and cheese, respectively. And, the relative wages are as follows: w/w* = (Pw/aiw)/( Pc/aic*) = (Pw/Pc)( aic*/ aiw) = (15/16)(6/2) = 2.81...
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