Neo Classical Trade Theories Coursework 1

In this activity, you are going to analyse within the neoclassical trade theories the impact of the
addition of one country to a constituted trade bloc.
Choose a neoclassical trade model (i.e. Ricardian, Specific Factor or Heckscher-Ohlin) and apply the
model for the particular case of a 2 good, 2 country model. For the case of the number of production
factors, choose the number consistent to what you have seen in class.
1. Write an introduction to the exercise in which you explain the main characteristics of the
model you choose and how this exercise could be useful/ applied to the reality. Include in this
section the main assumptions of the model you are going to analyse and briefly compare this
model with the other neoclassical trade models. (ca.300 words) [20 marks]
2. Explain the mechanics of the model. For doing so, describe how the equilibrium is achieved in
the autarkic economy. Then proceed to open up the economies to free trade and discuss the
gains from trade in this context. (ca.700 words) [35 marks]
3. Consider that both countries are already opened to trade with each other (like in a trade bloc)
and a third country wants to join the trade bloc. How will each countryโ€™s welfare be affected
by the addition of the third country to the trade agreement? If the real remuneration for each
production factor has, been affected differently by the third country joining the trade
agreement, who will be in favour and who will be against? Discuss. (Hint: It will be simpler to
analyse this question if you just assume that the third country is identical to one of the other
two. That should be enough to extract conclusions about the more general case) (ca. 500
words). [45 marks]
Each part indicates the recommended amount of words excluding graphs, equations and references.
While words are restricted to approximately the number above, you are encouraged to provide the
equations and graphs needed to support your answers. You can also include an appendix with
additional equations but the content of this appendix must be properly referenced in the main
document.
If you feel that you need more words in one part, you can borrow words from other parts of the
assignment. The overall number of words should not overcome the total amount of words for the
assignment (1500 words). If the number of words exceeds more than 5% of the total, a penalty will be
applied. This penalty will depend on the number of words that exceed the total.
If you choose the Ricardian model, please use this data and instructions:
Good/Country Home Foreign
x 0.125 1/6
Y 0.25 0.5
Table 1: Productivities in the two countries: Home and Foreign.
And L=200 and L*=100 where L and L* respectively represents the population size at both one country
that we could call home and the other country that can be called foreign.
Use the following relative demand function: ๐‘„๐‘ฅ
๐‘„๐‘ฆ
=
4๐‘ƒ๐‘ฆ
3๐‘ƒ๐‘ฅ
Explain carefully in a mathematical appendix how you construct the world relative supply curve and
how you compute the equilibrium in free trade.
For illustrating the gains from trade, use the consumption possibility frontier method.
In the three cases, autarky, free trade, and free trade with the third country, compute the quantities
consumed and produced. Show your mathematical work in the appendix.

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