EC351 International Trade Class 5

The Standard Trade Model

Problem 1

Assume an economy with two sectors, food and clothing and two factors of
production labour and capital engaged in trade with the rest of the world. Given that
food is more labour intensive than textiles and this economy is relatively well
endowed in labour answer the following questions:

a. On a diagram show the free trade equilibrium of this economy with the rest of the
world given that it is a net exporter of food.

b. What would be the impact on the welfare of this economy if the world demand for
food relative to clothing increases?

c. If the rest of the world experiences growth in its import-competing sector, what
would be the welfare implications on this economy?

d. Under what circumstances would growth in the food sector of this economy result
in an overall decrease in the welfare of its people?

e. Would growth in the food sector of this economy decrease its welfare if this
economy was small?

Problem 2

Under what circumstances would foreign aid or income transfer from the United
States to Pakistan partially compensate the donor in terms of welfare assuming that
both countries engage in mutually beneficial trade?