Countries Home and Abroad have two factors of production, land and labour, with which they produce two goods, wheat and wine. Technology is the same in the two countries, characterized by constant returns to scale and strictly increasing production functions with decreasing marginal products. Wheat is land-intensive, wine is labour-intensive; Home is land abundant, Abroad is labour abundant. Consumers' preferences are identical.
a) Assume Home and Abroad cannot trade with each other. Describe the differences in the two countries' outputs and prices of wheat and wine, the rate on capital and the wage rate.
b) How will trade between the two countries affect those?
c) Analyze the effects on output, the wage rate, rate on capital, welfare and terms of trade (price of exports over price of imports) of the following:
i) An increase in Home's labour supply.
ii) An increase in Home's amount of land.
(a) Here we can see that Home has an absolute advantage of producing wheat over Abroad. Now as the supply of wheat is high in Home, the price of wheat would be lower with surplus. Whereas for Abroad, low level of supply the price of wheat would be extremely higher with shortage.
Similarly Abroad has an absolute advantage of producing wine over Home. Now as the supply of wine is high in Abroad, the price of wine would be lower with surplus. Whereas for Home due to low level of supply the price of Wine would ...
This solution is comprised of a detailed explanation of economic concepts such as factors of production, land and labour.