Question 1 (10 marks)
Assume that Mexico has a higher labour to capital ratio than the United States, leaving the United States well endowed with capital relative to Mexico. Assume also that clothing is labour intensive in production relative to automobiles.
a) Label the two production possibilities frontiers indicating which one represents Mexico and which one represents the United States. (1 mark)
b) Draw in the line showing the equilibrium-relative commodity price in isolation in each nation. Which one is steeper? What does this mean? In which country are automobiles relatively more expensive? (3 marks)
On the graphs below show, for each nation with trade, the direction (by an arrow on the production frontier) of specialization in production and the equilibrium point of production and consumption. (2 marks)
d) How much does each nation gain in consumption compared with its autarky point?
e) Explain what would be expected to happen to wage rates and the price of capital in Mexico and in the United States according to the factor price equalization theory.
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