Now we will introduce trade.
We’ll solve this problem with 2 assumptions:
– Complete specialization: Home only produces one good. Foreign only produces one good.
From class these numbers should be 32 potatoes from Home and 24 meat from Foreign.
Don’t have Solver try and figure this out.
– Trade Price given: we know the price must fall between 2-4, so let’s just make it 3 units of
potatoes to 1 unit of meat.
The way to get Solver to figure this out is to have the Choice Variable be the amount of potatoes
Home sends off to Foreign. Divide that number by the price of 3 to get the amount of meat they
get in return. Let’s keep the price of Potatoes at $24, which makes the price of Meat now $72
in both countries. This should then determine the consumption levels for both Home and Foreign,
giving a new Global Utility of 10.23! Both Home and Foreign will be made better off.
(You can also model it with the total amount sent from Home for each good – but one of these
values will be negative, which Solver might give you trouble for)
a) What is the optimal consumption/production choice for Home and Foreign? (5 marks)
b) What Utility number does Home receive? What Utility number does Foreign receive? (2)
c) If the price of potatoes is $24/unit in both countries and the price of Meat is $72 in both
countries, what are the…
i) Wages in Home and Foreign? (1)
ii) What happens to the relative wage W/W*? (1)
iii) Real Wages in both countries in terms of both goods? (1)