Suppose that a country produces two goods, X and Y, and it is relatively well endowed in labor compared to capital. Assume also that production of good Y is relatively intensive in its use of capital, and good X is relatively intensive in its use of labor. In moving from autarky to free trade, the price of good X relative to the price of good Y increases.

1. (i) Using an Edgeworth Box of production, carefully explain the conditions necessary for there be efficiency in production of X and Y at the initial set of relative prices.

2. (ii) Referring to the Stolper-Samuelson theorem, explain in detail why the factor price ratio will increase given the change in relative goods prices. Provide the basic economic intuition behind this result.

3. (iii) Will the capital/labor ratio in the production of goods X and Y be the same under free trade as under autarky?

4. (iv) In what way does the Stolper-Samuelson theorem help us understand the uneven distribution of the gains from trade?

5. (v) Explain why with trade, there will also be a tendency towards factor-price equalization in this model.

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i In order for there to be efficiency in production of X and Y at the initial set of relative prices ... View the full answer