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Consider the following pre-trade data for Home in a Heckscher-Ohlin model with two goods (wine and cheese) and two factors (capital and Labour).

aKC =5 hours per kg (unit of capital requirement in cheese)

aKW =10 hours per litre (unit of capital requirement in wine)

aLC =15 hours per kg (unit of labour requirement in cheese)

aLW =20 hours per litre (unit of labour requirement in wine)

PC =$80 (price of cheese)

PW =$110 (price of wine)

a. Solve for equilibrium pre-trade wage and rental rate, remembering that due to the perfect competition problem and zero economic profit, P= MC, or P = aK . r + aL .w, in each sector, where aK and aL are capital and labour requirement in their respective sector, and w and r represent the cost of labour and capital per hour.

b. Now suppose that a comparison with the rest of the world has revealed that Home has a comparative disadvantage in cheese so that when trade starts the price of cheese in Home falls from $80 to $75. Solve for the post -trade equilibrium wage and rental rates.

c. What has been the impact of trade on the real return to the factors of production? Does your answer corroborate the Stolper- Samuleson theorem? Why?

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