Question

: Standard Trade Model. Assume that two countries are identical in everything (same technology, same type and level of endowments, etc...) except for their tastes. Country 1 tends to favor good Y over good X while Country 2 tends to favor good X. 2. In a diagram below, now show what happens when countries 1 and 2 trade with each other. In the diagram you need to show the following: (i) the PPF, (ii) each country's CIC (i= 1, 2) with trade, (iii) the relative price for both countries with trade (P/P, ), (iv) production and consumption when there's trade (Q and D, i = 1,2, for production and consumption respectively). Also show the exports and imports of both countries (hint: use AY,AX1,AY, and AX, for l's imports of Y, and exports of X, etc....).

Answer 1

In a Standard Trade Model, two countries trade based on their differing tastes, allowing them to specialize in producing and exporting the good they prefer less and importing the good they prefer more. This leads to both nations consuming beyond their PPF.

Step-by-step explanation:

Standard Trade Model Diagram Explanation

In the context of economics, when two countries are identical in all aspects except for their preferences for goods, trade can benefit both nations by allowing each to specialize according to their tastes. In this scenario, Country 1 has a preference for Good Y, while Country 2 prefers Good X. This can lead to a pattern of trade where Country 1 exports Good Y and imports Good X, whereas Country 2 does the opposite.

The Production Possibility Frontier (PPF) represents the maximum feasible outputs that a country can produce with its resources. If both countries have the same technology and resources, they will have identical PPFs. However, their Consumption Indifference Curve (CIC) will differ based on their preferences. With trade, both countries will be able to consume beyond their respective PPFs, typically at a point where their CIC is tangent to a common trade line that represents the relative price of goods with trade.

The relative price with trade will be determined by the intersection of the countries' demand and supply for Goods X and Y in the international market, which dictates the terms of trade (ToT). Through trade, both countries move from a point on their PPF to a point on their CIC, indicating their production (Q) and consumption (D) after trading. Country 1 will export Good Y (denoted as AY2) and import Good X (AY1), and Country 2 will export Good X (AX1) and import Good Y (AX2).