Question: (10 points) Consider two countries: Home and Foreign. Before opening up to international trade, the price of car relative to TV is 5/6 in Home

(10 points) Consider two countries: Home and Foreign. Before opening up to international trade, the price of car relative to TV is 5/6 in Home and 2/3 in Foreign. The production of car and TV uses labor as the input. Labor is mobile across sectors. (a) (3 points) Suppose these two countries open up to trade, and the world price of car relative to TV is 4/5. Explain the pattern of trade, and the pattern of production in the two countries under free trade. Is the pattern of production identical to that before opening up to trade? Explain your reasoning. (b) (7 points) Suppose the world price of car relative to TV changes from 4/5 to 3/4. Explain the effects of this change on the terms of trade, employment, exports, imports and trade balance of the two countries. Are Home workers better off? How about Foreign workers? Explain your reasoning.

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