Question

Suppose each worker in the home country can produce 2 cars or 10 TVs, and each worker in the foreign country can produce 10 cars or 2 TVs. Assume that the total number of workers in both countries is 100.

Suppose the world price of car relative to TV with free trade is 2.

1. Which good will each country produce, export and import? Explain your reasoning.

2. Calculate the quantities of output of cars and TVs in the world market

3. Suppose consumption of cars in the home country with free trade is 25 cars. Calculate the quantity of cars that are traded between the two countries.

4. Using the information in Parts (a)-(c) to calculate the quantity of TVs that are traded between the two countries

Answer 1

Home:
Total cars produced = Number of workers*Per worker production = 100*2 = 200
Total TVs produced = Number of workers*Per worker production = 100*10 = 1000

Foreign:
Total cars produced = Number of workers*Per worker production = 100*10 = 1000
Total TVs produced = Number of workers*Per worker production = 100*2 = 200

1. Opportunity cost of 1 car in home = Total TVs given up/Total cars produced = 1000/200 = 5 TVs
Opportunity cost of 1 car in foreign = Total TVs given up/Total cars produced = 200/1000 = 0.2 TV
So, Foreign has a comparative advantage in cars because of lower opportunity cost. Thus, Foreign will export cars and import TVs.

Opportunity cost of 1 TV in home = Total cars given up/Total TVs produced = 200/1000 = 0.2 car
Opportunity cost of 1 TV in foreign = Total cars given up/Total TVs produced = 1000/200 = 5 cars
So, Home has a comparative advantage in TV because of lower opportunity cost. Thus, Home will export TV and import cars.

2. Total Cars = Production by Foreign = 1000
Total TVs = Production by Home = 1000

3. Quantity of cars traded = Total cars produced - Consumption of cars in home country = 1000 - 25 = 975 cars

4. The world price of car relative to TV with free trade is 2. So, if 25 cars are traded then their price is 25*2 = 50 TVs
Thus, 50 TVs are traded.
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