This problem is based on the Ricardian Model. Assume that 2 countries, Stormland

Question

This problem is based on the Ricardian Model. Assume that 2 countries, Stormlands and Reach, use White Walkers' labor to produce 2 goods, lumber and wheat.

(a) Use the information below to calculate the numbers instead of "?" marks in the Table. (Show and explain all your calculations).

In The No-Trade Equilibrium

Stormlands:

WageL = 24 WageW = ?

MPLL = 4 MPLW = ?

PL = ? PW = 4

Reach:

Wage*L = ? Wage*W = 6

MPL*L = ? MPL*W = 1

P*L = 3 P*W = ?

(b) Which country has a comparative advantage in wheat and why?

(c) Suppose that in the trade equilibrium PL/PW = 1.2. Which good which each country export?

(d) For each country, calculate the real wage in terms of lumber and in terms of wheat.

(e) For each country, compare the values you obtained in part (d) with the real wage in terms of either good in the no-trade equilibrium. Do White Walkers in each country gain from trade?

Explanation / Answer

a) Stromlands

for equilibrium

=>MPPL =WageL/P

=>4 = 24/PL

=>PL = 6

also for trade

WageL/PL =WageW/PW

=> 24/6 = wageW/4

=> WageW = 16

=> MPLW = 16/4 =4

=>

Stormlands:

WageL = 24 WageW = 16

MPLL = 4 MPLW = 4

PL = 6 PW = 4

similarly for Reach

Reach:

Wage*L =3 Wage*W = 6

MPL*L = 1 MPL*W = 1

P*L = 3 P*W = 6

(b) stromlands has comparitive advantage in wheat as it hasMPLW =4 which is greater than MPLW of Reach =1.

c) If PL/PW = 1.2 , Wheat will be exported from stromlands as it has PL/PW =6/4 =3/2

As it is greater than 1.2

d)real wage for lumber in stromland = 24/4 =6 ,real wage for Reach = 3/3 =1

real wage for wheat in stromland = 16/4 =4 ,real wage for Reach = 6/6 =1

e)As in equilibrium real wage is decreased . so both countries gain from trade

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