Assume we are in a Ricardian world where there are only two countries: England and Portugal. These countries produce two goods: cloth (C) and wine (W). Table 1 reports some information regarding each country’s technology, wages and prices in autarky.

1. What is the wage in the W sector in England? What is the wage in the C sector in Portugal? Explain your answer.

1. Given the information in table 1, derive the marginal product of labor in the C and W industry in England and in Portugal. Show the formulas underlying your calculations.

1. What is the real wage in England in terms of C and in terms of W? Show the formulas underlying your calculations.

1. What is the autarky relative price of C in both countries?

Question #2

Continuing from question 1, assume that countries are free to trade and that the world relative price of C is equal to 1.

1. What is the real wage in England in terms of C and in terms of W?

1. How do these values compare to the real wage of either good in autarky?

Question #3

Italy and Australia produce wine (W) and guitars (G). Guitars are produced using capital and labor. Wine is produced using land and labor. Labor is mobile between sectors within a country. Italy is relatively abundant in capital, while Australia is relatively abundant in land. Consumers’ preferences are the same in Italy and Australia.

1. a) Draw the relative demand and the relative supply of guitars/wine for each country in autarky. Explain any difference across country.

Now, suppose Italy and Australia are free to trade.

2. d) Using the diagram below, show and discuss what happens to the allocation and wage of Italian labor going from autarky to free trade. For simplicity, assume that the price of the good imported by Italy stays unchanged.

1. e) How does free trade change real wages in Italy? Explain your answer in as much detail as possible.
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