Rovnova Yulia International Economics Assignment 1 Question 1: a) Lets determine relative price of Tequila in Mexico and the United

States. In pretrade equilibrium relative price of Tequila equals to opportunity cost of Tequila, because wages in both industries (Tequila and Rice) would be equal, so the labor will be hired up the point at which the wage in both industries equal: Pt t=Pr MPLr. Mexico: Pt/Pr=MPLr/MPLt: MPLr/MPLt=5/7 USA: Pt/Pr=MPLr/MPLt: MPLr/MPLt=2 b) Given results in (a) USAs opportunity cost (MPLt/MPLr) of producing pound of Rice is which means USA has to give up bottles of Tequila to produce 1 pound of Rice. Mexicos opportunity cost of Rice is 7/5. So Mexico has to give up 7/5 of bottle of Tequila to produce 1 pound of Rice. Given these results we can make the conclusion that USA has a comparative advantage in producing Rice because opportunity cost of Rice in USA is lower than in Mexico. c) When both countries (USA and Mexico) will engage in international trade relative prices would change. Because USA has comparative advantage in producing Rice, it will export Rice, and Mexico will export Tequila because it has lower opportunity cost of Tequila. So countries will export the good in which they have a comparative advantage. In pre-trade equilibrium relative price of Tequila in Mexico was Pt/Pr=5/7, and relative price of Tequila in USA was 2. So the international relative price of Tequila would have the value in between these two values: 5/7<Pworld<2 So in order for Mexico to engage in international trade the relative price of Tequila should be bigger than 5/7. d) Now lets suppose that total number of laborers in the USA is 300 while number of workers in Mexico is 2. Which country gains more from trade? Because USA has comparative advantage in producing Rice, then by Ricardian model we can come to the conclusion that USA will specialize in production of Rice. Since the international relative price of Rice has increased relative to pre-trade relative price of Rice in USA, the wages of laborers in the Rice sector would increase. Wages in the USA in Rice sector are higher than wages in Tequila sector, so all USA workers would want to work in Rice sector, and no Tequila will be produced. In that case production of the USA will be 300 laborers*10 pounds of rice per hour=3000 pounds of rice per hour. Now with a new international relative price of Rice that is bigger than USA pre-trade relative price there will appear new consumption possibilities for USA that were not available before trade. With a new price line that has a steeper slope than pre-trade price line we can find an intersection point with indifference curve that would give us higher utility level. If USAs utility increases with trade, it means the country gains from trade. Similar situation will happen to

Mexico, but in case of Mexico, country would specialize in production of Tequila, because of lower opportunity cost. This means that Mexico would specialize in production of Tequila, and all workers from Rice sector would move to Tequila sector. Thus, we see that in Ricardian model both trading countries would specialize in production of a good in which they have comparative advantage. So no matter how many workers are in the country, both countries would gain from trade.