Suppose two countries, A & B, produce two goods each, X and Y. Y is capital intensive, while X is labor intensive. The two countries have identical preferences for both goods. Country A exports good Y and imports good X, but it does not completely specialize.

A) Which country has the higher autarky price ratio Px/Py? How do you know?

B) Sketch graphs for each country given the information above. Include the PPF, the indifference curves, show the production and consumption levels of ONLY good X. Try to make the exports/imports balance graphically if possible. (Hint: the shapes of the indifference curves will need to be different between the two countries. Use the fact that each country is specializing in a different good to help guide you in drawing the graphs).

C) Sketch the Excess Demand and Excess Supply curves for good X. Indicate the general equilibrium price P*

Suddenly, Country A has to reduce the amount of labor available. The level of capital however, remains constant.

D) What happens to A's PPF? Be specific. Sketch this graph on the same picture that you made for part B, in a DIFFERENT color.

E) How does A's excess demand curve change since labor has been reduced? Sketch this on the graph in part C, in a DIFFERENT color.

F) Does Country B experience any increase or decrease in welfare as a result of the reduction of labor in Country A? Please explain why.