Effects on factor prices, Microeconomics

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Assuming the Heckscher-Ohlin model is true. Suppose the Cuba and Russia sign a free trade agreement. Furthermore, assume the Cuba and Russia only produce cigars and vodka. Russia has comparative advantage in producing vodka (a K intensive good) and Japan has comparative advantage in producing cigars (a L intensive good). Using supply/demand curves and PPFs to show the following :

(a) Draw both countries PPFs on the same graph and show what happens to quantity of cigars and vodka each country chooses to produce before and after trade. Label your graph fully (i.e. identify each country's ppf, autarky points on ppf, post-trade points on ppf, gains from trade)

(b) Using supply/demand graphs show the effects on factor prices after the Free Trade agreement is signed.

(c) Explain why a country with comparative advantage in the labor intensive good may choose to completely exploit their comparative advantage in that good.


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