Question

Consider a Ricardian world consisting of U.S. and Japan. Both countries produce and consume the same two goods: cars and computers. In U.S., it takes 200 hours of labor to make a car, and 50 hours of labor to make a computer. In Japan, it takes 200 hours of labor to make a car, and 100 hours of labor to make a computer. Each country has 2 billion hours of labor.

a. What would the autarky equilibrium (i.e., the amount of each good produced and consumed as well as the relative price of each good) in these two countries be if each devotes 80% of its labor force to the production of cars and the rest to the production of computers? Show the autarky equilibrium for each country in a graph with the respective numbers on the graph.

b. Which country has absolute advantage in cars? In computers? Why?

c. Given the answer to b, would U.S. have any incentive to trade with Japan? Who has comparative advantage in what? Why?

d. If there is free trade, what would the world relative price of a car be if both countries completely specialize?

e. If there is free trade, what would the wages in Japan relative to the wages in U.S. be if both countries produce cars?

f. Suppose there is free trade and the world demand for computers exceeds 40 million. Who would produce what? What would the U.S.'s commodity terms of trade be? What would the Japan's commodity terms of trade be? Which country would be `small'? Explain.

Answer 1