Reference no: EM133084358

There are two countries, Mexico and Chile, and two goods, copper and oil. Copper requires copper mines as a specific factor while oil requires oil reserves as a specific factor. There is one other factor, labor, which is mobile across sectors. Assume Mexico exports oil and Chile exports copper.

A. Graph the production possibilities frontier for Mexico.

B. If the world price ratio of copper to oil was copper/oil, show, on the graph above, how much copper and how much oil Mexico would produce. Label these quantities q 1 copper and q 1 oil.

C. Show how much oil and copper Mexico consumes on the graph above. Label these quantities d 1 copper and d 1 oil. Draw as many indifference curves as you need to.

D. Suppose the price of exports from Chile increases (there are imports into Mexico). Show, on the graph above, how the production of oil and copper would change in Mexico. Label these quantities q 2 copper and q 2 oil.

E. Show how much oil and copper Mexico consumes at the new international prices. Label these values d 2 copper and d 2 oil. Draw as many indifference curves as you need to.

F. Did the change in international prices increase or decrease income in units of oil in Mexico?

G. Show in a graph-like the one we used in class where we have labor in Mexico on the x-axis and wages on the y-axis-how the equilibrium wage changes in Mexico after the international price of copper increases. Further, assume that the international price of oil is one.

H. In which sector (copper or oil) does labor demand increase when Mexico opens to trade? What happens to the real wage in terms of copper and the real wage in terms of oil in Mexico?

I. How does the distribution of income change in Mexico? Answer this question by listing what happens to the return to each of the three factors of production. Is this result contradicting you answer to part F?

J. Given the real wage changes from part H, what assumption on preferences would imply that labor in Mexico loses from opening to trade?