Assume a Heckscher-Ohlin model of trade. Australia (AUS) and New Zealand (NZL) produce paper (P) and carpets (C) using two factors, capital (K) and labor (L), that are mobile across sectors. Paper production is capital intensive and carpet weaving is labor intensive. Further, Australia has 120 units of labor and 120 units of capital, while New Zealand has 100 units of labor and 80 units of capital. The cost of labor is
w. The cost of capital is r.
a) Which country is capital abundant relative to the other country? Explain why.
b) In the diagram below, draw the relative demand and the relative supply of paper/ carpets for each country in autarky. Explain any difference across countries.
