Econ 355 UBC

+ Consider a specific factors model with two 4. RSN goods: A and M. Labour is mobile between P/P RSW sectors. Capital (K) is used only in M and RD RSS Land (T) is used only in A. There are 3 countries: North (N), South (S) and East (E). South has a comparative advantage in M W (relative to North) as illustrated in the diagram. There is initially free trade between North and South. (with a free trade price pm / p, ) East initially does not trade with either of them. M/A Suppose that East is completely identical to South (it has the same supply of K, L and T and same technology. So East's RS curve is the same as South's. Suppose now that there is a free trade agreement between North, South and East. a. Using the relative supply and demand diagram, illustrate what happens to the world relative price of M (i.e. pm / PA ) b. What happens to the terms of trade in North and South? Why? Does the free trade agreement increase overall consumption possibilities in North? What about South? Use the production frontiers and budget constraints to answer this. c. What happens to the real returns to land, labour, and capital in the South? Use diagrams