Consider trade between two countries that have the following unit labor requirements for the production of cheese and wine: Home Foreign ac= 10 ac*= 6 aw= 1 aw*= 2 L = 200 L* = 120 a) Which country has an absolute advantage in cheese/wine and which country has a comparative advantage in cheese/wine? What are the relative prices of cheese at Home and in Foreign assuming they are in autarky (closed economies)? b) If consumer preferences are given by U( xc , xf ) = xc2/3xf1/3 , find the equation for the relative demand curve. Use this to find the free trade price if both countries engage in free trade. Would both countries gain from trade?
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