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Suppose two countries, H and F, are in international general equilibrium at some price ratio P*=Px/Py. They produce two goods, X and Y, using two factors of production, L and K. Y is capital-intensive, X is labor-intensive. The two countries have identical preferences for the goods. H exports Y and imports X, but it does not completely specialize. All other conditions of the “Workhorse” Model developed in lecture apply in this situation.
a) Which country has the higher autarky price ratio Px/Py? How do you know?
b) Sketch graphs for each country consistent with the above information. Include the PPFs, some representative indifference curves and clearly indicate production/consumption levels of good X(you can ignore Y) at the general equilibrium price P*. Try to make the exports/imports balance graphically, but given the time constraint of the exam that may not be possible. [Hint: The shapes of the indifference curves will need to be different between the two countries. Use the fact that each country is specializing in a different good to guide you in how these PPFs must look.]
c) Sketch the excess demand/supply curves for good X. Indicate the general equilibrium price P*.
Suddenly, H experiences a plague, sickening workers and reducing the labor available. The level of capital remains constant.
d) What happens to H’s PPF? Be specific. [Hint: is the changing position of the PPF biased one way or the other?] Sketch this graph on the same picture that what you made for part b.
e) How does H’s excess demand curve change as a result of the plague? Sketch in this graph on what you did for part c. Identify the new general equilibrium price. [Hint: you will probably want to utilize your graph from d to help you figure this out.]
f) Does F experience an increase or decrease in welfare as a result of the plague in H? Briefly state why.
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