Mohammed VI Polytechnique - U

FGSES
ECO 309
Assignment 1, Due : Jan 23rd 2023

Plz submit by teams of 3 students. Submitted work has to be neat and respect accepted rules for
university work.

Winter 2023 F.R. Sinaceur

1. The following problem investigates the autarkic equilibrium in the HOS model in the context of
the foreign country and is intended to train you in general equilibrium analysis. It is merely a
repetition of what we did in class applied to the foreign country.

Consider the Foreign country (F). There are two types of consumers. Consumers that belong to
Type 1 own labor (L), and the consumers of Type 2 own capital (K). There are two final goods
for consumption, X1 and X2 and both consumer types derive utility from consumption according
to :

Consumers face prices P1 and P2 for goods X1 and X2 and have income M where M1 = wL is type
1 consumer’s income and M2 = rK is type 2 consumer’s income.

X1 and X2 are produced according to the following Leontieff production technologies:

X1= min {L1/4, K1/2}

X2= min { L2/1, K2/4}

Labor costs w and capital costs r and the country’s factor endowmwnts are L = 10 and K = 32.

1. Derive both consumer’s types demand functions for the two goods X 1 and X2 as a function of
prices P1, P2, M1 and M2 and label them where i = 1, 2 stands for the good and j = 1, 2
stands for the consumer’s type.

2. Derive the conditional labor and capital demand functions in both industries as a function of
factor prices and output.

3. Write down the profit maximization problem in each industry. Substitute for L 1, K1 , L2, and
K2 from above, normalize P2 = 1 and derive the Solper-Samuelson equations.

4. Write down the full employment conditions, substitute for L 1, K1 , L2, and K2 from (2) and
derive the supply equations. Explain why supplies are vertical, i-e, they do not depend on
price P1.
5. Find the general equilibrium in this economy, i-e P1/P2 such that the two markets are
simultaneously in equilibrium.

6. Given your results in 1. through 4., find the values for the equilibrium wage (w), rental rate of
capital (r), the levels of consumption for each type of consumer of both goods, the utility
levels of each type and the country’s aggregate level of utility.