Consider the following model of trade between Finland and Iceland. Suppose through that those two countries are the only two countries in the world, at least for purposes of trade. There are two goods: Wheat and Fish. Customers always spend one fifth of their income on fish and rest on wheat. The only factor of production is labor. Each Icelandic worker can produce 1 unit of wheat or 1 unit of fish per unit of time, while each finnish worker can produce two units of fish or four units of wheat per unit of time. There are 1 million workers in Iceland and 1.5 million in Finland.

Question:

1. Discover the Autarky relative price of fish in both countries. (i.e the price of fish divided by the price of wheat), and draw the typical worker's budget line in both countries.

2. Derive the relative demand curve relating the relative demand for fish to the relative price of fish. Do this algebraically and then show what the curve looks like in a diagram with the relative quantity of fish on the horizontal axis and the relative price of fish on the vertical axis.

3. Derive the world relative supply curve and draw it on the same figure as you created for part (5).

4. Calculate the equilibrium relative price of fish under a free trade, and draw the budget lines for a typical worker in each country. Which country produces which goods? Is there complete specialization? Who gains from trade?