*Please label the part of the question you are answering. Chile and the Ricardia

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Chile and the Ricardian Model: Assume that Chile can produce two goods: manufactures and copper. The technology to produce manufactures and copper both only use labor and they have constant marginal products of labor. The marginal product of labor in manufactures is 5. The marginal product of labor in copper production is 10. And the total quantity of labor in the economy is 100 units. Furthermore, assume that Chile is a “small open economy”, that is it takes world prices as given and Chile has no impact on international supplies and prices.

a. If Chile is in autarky, what is the relative price of copper to manufactures?

b. In May 2010, the world relative price of copper to manufactures was approximately 3/4. Would Chile want to trade internationally? If so, what product Chile will export, and what product Chile will import? Please carefully explain why.

Explanation / Answer

a) Under autarky wages in both sectors will be equal. This implies Pc*(MPL)c = Pm*(MPL)m . Theefore, relative price is

Pc/Pm = (MPL)m / (MPL)c.= 5/10 =1/2.

b) Opportunity cost of copper = 5/10 = 1/2. So chile will trade copper since opportunity cost is less than relative price. Chile will export copper and import manufactures.

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