In an endowment model of trade with two countries, each with endowments of two g

Question

In an endowment model of trade with two countries, each with endowments of two goods C and F, E(C) and E(F) are the endowments of good Cand F in Home, respectively, and E°(C) and E°(F) are the endowments of C and Fin Foreign, respectively. Consumers in both countries have identical preferences. Prices at home under Autarky are referred to as P(C)/P(F), and in the foreign country under Autarky they are P(C)/ P"(F). Under free trade, prices are Pw(C)/ Pw(F) If it's the case that E(C)/E(F)E(C)/(F), then the three prices defined above have which of the following relationships? O Aa. (P(C)/P(F)) (Pw(C)/ Pw(F))(P(C)/ P°(F)) B b. (PwlO/ PW(F) )

Explanation / Answer

Consider the given problem here there are two countries “Home” and “Foreign” and there are two goods “C” and “F”. Now, we have given that “E(C)/E(F) < E*(C)/E*(F)”, => “Foreign” country has relatively more “C” compare to the home country and “Home country” has relatively more “F” compare to the “Foreign country”.

So, which implied the relative price of “C” in foreign country must be less than the relative price of the home country, => “P*(C)/P*(F) < P(C)/P(F)”. So, if these two countries trade with each other, => the equilibrium relative price of “C” must be more than “P*(C)/P*(F)” and less than “P(C)/P(F)”. So, the following condition must hold.

=> P*(C)/P*(F) < Pw(C)/Pw(F) < P(C)/P(F).

SO, the correct answer is “C”.

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