show the answer in details. 3. [60 marks, equal weights for all subquestions] Consider the Specific Factors model with two countries, Horne and Foreign, with two goods, cars (0) and

show the answer in details. 3. [60 marks, equal weights for all subquestions] Consider the Specific Factors model with two countries, Horne and Foreign, with two goods, cars (0) and pharmaceutical
drugs (d), and three factors, capital K, skilled labour 8, and unskilled labour L. The production functions are given by
1 l 1 l.
FC(KC, LC) 2 KELE and FAR/(1,8,1): K38}. That is, skilled labour is specific to pharmaceutical drugs, and unskilled labour to
cars. Suppose that the countries” factor endowments are KH 2 2 = KP, LH = 1
and LF 2 3/2, and SH 2 1 and SF 2 1/2, so that the total labour force is 2 in
both countries. The price of capital is denoted by r, the price of skilled and unskilled
labour by w, and "an. Denote the goods” prices by pC and 330;, and normalise pd : 1 for simplicity. The demand for cars and drugs in country j = H, F is given by 3:”; and 51:3,: . 2Y5 . 1Y3′
rz:——.and:LJ:——.,
313g 3p:i where Yj denotes aggregate income in country j. (a) Draw or compute the PPFs of Home and Foreign.
(b) Derive the autarky equilibrium in Home, showing that Kf’ = 4/ 3 and pCH = x/2. (c) Compute the autarky equilibrium in Foreign and show that pf > pf . Compare equilibrium prices in Home and in Foreign and explain. ((1) With free trade in both goods 0 and d, which good will Horne export, and will skilled or unskilled workers be better off? Explain or compute. (e) Suppose that there is now both free international trade in goods and also in
the factor capital, i.e. capital is mobile between the two countries and the two
industries, and that the world market price p: Z 1. Compare the resulting world market equilibrium allocation to autarky and to free trade in goods (verbal explanation or computation). (f) Suppose that now that Foreign has a production technology 2 Ff(K._., S.) : 2K§ LE and FflLd, 8d) : 2K§S§. Describe the effect of free trade in goods but not factors (compared to autarky) in
terms of the resulting world market equilibrium good price and wages (explain, no computation needed).

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