In the Ricardian Model studied in class, with countries Home and Foreign and wit

Question

In the Ricardian Model studied in class, with countries Home and Foreign and with two goods under trade, assume aLC/ aLW «aLC/ aoLW where aLC and a LW are unit labor requirements for cloth and wine in Home and aLC and aLW in Foreign. Suppose a Home- export biased catch-up occurs in Foreign, ie. a"LC decreases. Then it is the case that O A The relative price of cloth (vs. food) may go down. O B The terms of trade of Foreign must improve O CThe terms of trade of Home may remain unchanged. O D (A) and (C) O E None of the above

Explanation / Answer

Ans.

D. (A) and (C)

When unit labour requirement for cloth decreases then relative price of cloth (Vs. food ) may go down and terms of trade for Home may remain unchanged. That means when unit labour requirement for cloth in foreign will decrease then ratio of relative price in foreign will decrease. There will not be any any effect on terms of trade in home country because in foreign there has been reduction in a0LC.

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