Please answer ALL questions and submit your individual solutions by 5pm UK time on
Monday, 2.8.2021, through the submission link on Blackboard as a single pdf le. Please
use MS Word etc. for wordy answers, but legible, handwritten solutions are acceptable
as well, in particular for mathematical derivations. Always explain your workings and
answers. Please remember to properly reference, if basing (part of) your answer on
academic literature or textbooks.
1. [20 marks] Suppose a limited number of WTO member countries consider entering a
customs union with zero taris within the union and common taris on imports from
countries outside of the union. What will be the consequence for trade and welfare in
the world? Explain two dierent eects of the new customs union using the gravity
model and not more than three paragraphs.
2. [20 marks] For analysing questions about the impact of Brexit and the Christmas
2020 trade agreement between the UK and the EU, are Ricardian models or Specic
Factors models better suited? The answer should elaborate on which properties
(focus on two) of the two models are likely to be important for the analysis and end
with a conclusion and use not more than three paragraphs.
3. [60 marks, equal weights for all subquestions] Suppose Home H and Foreign F pro-
duce two goods, bread b and cheese c using only labour. In Home the unit factor cost
of bread is aH
b = 1 and that of cheese is aH
c = 2, and in Foreign aF
b = 1 and that of
cheese is aF
c = 3. Denote the goods’ prices by pb and pc, and denote the wage by w.
Suppose the demand for bread and cheese in Home is given by
where Y H and Y F are the aggregate incomes in Home and Foreign. Suppose the
labour force (i.e. population) in Home and Foreign is L each. Normalise the price for
bread by pH
b = 1 and pF
b = 1.
(a) Is this a specic factors or Ricardian model of trade? How will gains from trade
arise in this model? Explain your answer.
(b) Determine the equilibrium allocation (prices and quantities) in Home under
autarky, showing that in equilibrium pH
b = 2.
(c) Determine the equilibrium allocation (prices and quantities) in Foreign under
Now there is free international trade in goods (but not factors) between Home and
Foreign. Normalise the international market price for bread by pb = 1.
(d) Determine the world supply of bread and cheese depending on pc and show the
world market equilibrium price is p
c = 3.
(e) Derive Home’s and Foreign’s equilibrium production and imports and exports.
Will Home’s and/or Foreign consumers be better o with trade than in autarky?
(f) Suppose that Home opens up and admits labour immigration from Foreign, but
Foreign does not allow labour immigration from Home. What will be the new
equilibrium allocation (labour, goods and prices), still with free international
trade in goods? Compute or explain.