I want to relax the assumption of a fixed price. Have Solver pick that as well, but make sure to set up
a restriction so that the relative price PM/PP cannot be below 2, nor can it be above 4. This should
drive Global Utility up to 10.51, but you’ll notice the Foreign is made no better off than in Autarky.
One way to deal with this is to insert a “Bargaining Power” variable into our Global Utility function.
This allows us to tweak where the exchange rate winds up.
a) With a new Global Utility function of UG = UH + 2UF solve the optimal
consumption/production choice for Home and Foreign. You should get UG = 16.23 (5)
b) If the price of potatoes is $24/unit in both countries what…
i) is the price of Meat? (1)
ii) happens to the wages and the relative wage W/W*? (1)
iii) are Real Wages in both countries in terms of both goods? (1)
c) Suppose L increased to 108. What happens to your answers in (b)? Is Foreign better off or
worse off? Utility should go up for Home, but do the real wages tell the same story? Can
you explain this? (3)
d) Suppose we reduce aLM* to 3 from 4, how does it filter through the model? Does Home
benefit? Why? If we instead reduced aLP* to 1.5 from 2, does Home benefit? Why? (4)