Reference no: EM133710475

Question: Consider a world with two countries, Home and Foreign, and two goods: manufactures and food. The production of manufactures requires capital and labour whereas the production of food requires land and labour. Assume that both countries have the same technologies and the same amount of labour but they differ in their endowments of capital and land.

A researcher has computed the relative supply of Home, RS and of Foreign, RS* and has found that they have the form:

RS = (QM / QF) = 16? (PM / PF)

RS* = (QM / QF) = 2? (PM / PF)

Assume that the relative demand for manufactures is given by: RD = 60 - (PM / PF).

Plot both relative supply curves, RS and RS*, and the relative demand curve RD in the same RS-RD diagram (plot the relative price of manufactures in the y-axis). Use the diagram to determine the relative price of manufactures at Home and at Foreign if the two countries cannot trade with each other [NOTE: you do not need to compute the values algebraically].
Assume that both countries open to trade with each other. Explain how the relative price of manufactures changes in each country after opening to trade, and provide economic intuition behind your answer. Plot the world RS curve in the graph in part 1 to illustrate your answer [NOTE: You can draw a generic curve for the world RS: you do not need to compute it algebraically.]
In the free trade equilibrium, which country exports manufactures? And food? Provide economic intuition on why this is the case.
Based on your analysis, which country has the higher capital-to-land endowment ratio, K/L? Explain why this must be the case.
Use graphs to show how opening to trade affects the income of landowners and the capital owners in the Home country.