Assume that there are only two countries in the world, Stopland and Azuria, and that there are only two goods, motorbikes and potatoes. Motorbikes are labour intensive to make, and potatoes is land intensive to make.

a. 1) Assume that Stopland is more productive at producing all goods compared to Azuria.

Which country will have higher income? Please explain the reasons.

b. 2) Why might Stopland want to trade with Azuria, even if it is more productive at producing

all goods?

c. Now assume a slightly different situation: Stopland has an absolute advantage in potatoes

(motorbikes are expensive and potatoes is cheap in Stopland), and Azuria has an absolute advantage in motorbikes (potatoes is expensive and motorbikes are cheap in Azuria).

1). Under these conditions, Stopland and Azuria sign a free trade deal, and start to trade with each other (they go from having no trade to perfectly free trade).

i. (2) Which country will import potatoes, import motorbikes, export potatoes, and export

motorbikes and why?

ii. (3) What will happen to prices of potatoes and prices of motorbikes in each country,

and why?

iii. (4) In the short run, the labourers in which country will gain and lose? The landowners in

which country will gain and lose?

iv. (5) How will the labourers and landowners in each country be affected in the long run?

Explain why.