Question

Consider a Ricardian model where there are two goods: apples and bananas. For simplicity we will only consider one country called Alba (that is we will not think about its trading partner (or potential trading partner)). In Alba the unit labour requirement for an apple is 20 hours and for a banana is 10 hours. Alba has an endowment of 1000 hours of labour. Draw a production possibility frontier (PPF) diagram for Alba. Apples must be on the vertical axis and bananas must be on the horizontal axis. Suppose that if Alba does not allow its citizens to engage in international trade it will produce and consume 25 apples and it will produce and consume 50 bananas. Show this point on your diagram and label it PCA. Now suppose that Alba does allow its citizens to engage in international trade and the world price is 1 banana for 2 apples. Show on your diagram how many apples and how many bananas are produced in Alba; please label this point as PT. With international trade 80 apples and 60 bananas are consumed in Alba; please label this point as CT on the budget constraint. Finally, on your diagram label the quantity of exports and label the quantity of imports. On your diagram make sure that you state the quantities of exports and imports.

Answer 1

In the diagram above, we have shown production possibility frontier PPF and consumption possibility frontier CPF for the country Alba. With 1000 hours of labor, Alba can either produce 50 apples or 100 bananas. Thus, PPF for Alba has a vertical intercept of 50 and a horizontal intercept of 100. Initially, prior to trade, Alba was producing and consuming at point PCA. With world exchange rate of 1 banana = 2 apples, Alba will export 50 bananas (here Alba has comparative advantage in production of bananas) and imports 50*2 = 100 apples (at point PT). If Alba consumes 60 bananas, then, it can export 40 bananas and in exchange, imports 40*2 = 80 apples (at point CT). Points PT and CT are drawn on the CPF curve for Alba.