(1) France and Italy only trade with each other;
(2) each country is only capable of producing 2 goods, Wine and Bread;
(3) the production of Bread is relatively capital intensive, and the production of Wine is relatively labor intensive, and
(4) France is relatively abundant in capital, while Italy is relatively abundant in labor. All assumptions from our class about the Heckscher-Ohlin model hold, in particular the fact that both countries have identical homothetic preferences, constant returns to scale in production, the countries are the same size, etc…
For the sake of consistency, put BREAD on the X-axis of any PPF graphs you might be inclined to draw.
a. Compare the relative prices of Wine and Bread in each country under autarky. Be sure to thoroughly explain your answer, possibly using a graph(s) for a visual aid. (Answer should be at least one paragraph in length. Quality of your answer determines grade.)
b. Sketch excess demand/excess supply curves for Bread consistent with the scenario when the countries open for free trade. Be sure to carefully draw your graph and identify all relevant parts.
c. Describe what happens to factor payments in France with trade. Be sure to thoroughly explain your answer using what you have learned from the class. (Answer should be at least one paragraph in length. Quality of your answer determines grade.)
d. Academic research on alcoholism induces a change in preferences for the goods. In both countries, Wine becomes less desirable relative to Bread. In words and possibly with pictures, describe the impact of this change in preferences on the two economies. You should be sure to include a discussion on the changes in the prices of goods and production factors. (Answer should be at least one paragraph in length. Quality of your answer determines grade.)
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