Reference no: EM132502879

(a) Assume labour and capital are the only two inputs. Country M is a capital-abundant country that produces personal computers and fax machines. Computer production is capital intensive, and fax production is labour intensive. Capital can be employed in either the computer or the fax industry and can move easily back and forth between the two. Labor is specialized; some labor is suited to produce personal computers and other labor to produce fax machines. "Computer labour" is useless in producing fax machines, and "fax labour" is useless in producing computers.

If Country M opens trade with a country with identical tastes, what will happen in the short run to:

(i) Country M's production of computers and fax machines? Explain what information or theorem you use as the basis for your answer.

(ii) Justify the prices of computers and fax machines in Country M.

(iii) Explain what will happen to wages of computer labour in Country M.

(iv) Explain what will happen to wages of fax labor in Country M.

(b) Does factor price equalisation occur in the real world? Justify.

(c) Explain why trade diversion is considered harmful and trade creation is considered beneficial?