Imagine that there are only two countries in the world: Americaand China. Each country produces and consumes two goods – atradable good (T) and a non-tradable good (NT). The production ofthese goods involves the use of labour, but no other resources areused in the production process. This is of course a ridiculousassumption, but it is one we will make for the purposes of thisassignment. There are perfectly competitive markets for thenon-tradable good (NT) in each country, but no trade in this goodbetween the countries. There is a perfectly competitive globalmarket in the traded good (T). Labour is homogeneous withinAmerica. An hour of labour produces 10 units of the traded good (T)or 5 units of the non-traded good (NT) in America. Labour costs are10 dollars (USD) an hour in America. Labour is also homogenouswithin China. An hour of labour produces 5 units of the traded good(T) or 5 units of the non-traded good (NT) in China. Labour costsare 10 yuan (CNY) an hour in China.
Suppose that over time the productivity per hour of labour inChina in the tradable good industry increases to 10 units of T,while the other three productivity figures do not change. What willhappen to the real exchange rate? (1 mark)
