Question

Microeconomics: Comparative Advantage:

NOTE: I ONLY NEED THE ANSWER FOR (e)

California is very fertile. Farmers can produce avocados and corn on their land, 6 and 10 units per unit of land respectively. They have 5 units of land. In the Canadian prairies one can also grow avocados and corn, at 1 and 5 units per unit of land. There are 15 units of land. Assume both countries have perfectly competitive markets. Let the utility function of consumers in each country be U = A^1/2C^1/2. Demands are thus A= I/(2pA) and C= I/(2pC ).

(a) Who has the absolute advantage in producing avocados? Who has the absolute advantage in producing corn? Who has the comparative advantage in producing avocados? Who has the comparative advantage in producing corn?

(b) If California and Canada traded, then which goods would they trade in which direction?

(c) Let the price of corn be 1. For which range of prices for avocados would both countries produce avocados? For which range would only one country produce avocados? For which range would both countries produce corn?

(d) What is the total demand for avocados, if California only produces avocados and Canada only produces corn? What is the market price for avocados? Would farmers in each country want
to change their production decision at this price?

(e) Canadian farmers have improved their farming techniques. Now they can produce 6 units of corn per unit of land. What is the impact on Californians: are they better or worse off?

Answer 1

(e) If Canadian Farmers can produce 6 units of corn per unit of land, it means that they have improved there farming techniques. Since, Canada has 15 units of land, previously Canada could produce a total of 15*5 = 75 units of corn (without producing avocado) but now Canada can produce a total of 15*6 = 90 units of corn (without producing avocado).

Now, since Canada has a comparative advantage in producing corn Canada will trade corn with California. When Canada can produce 6 units of corn per unit of land, the opportunity cost of producing avocado decreases.

Previously,

	Avocado	Corn
Canada	1 (5/1 = 5)	5 (1/5 = 0.20)

Which means Canada gave up 0.20 units of Avocado to produce a unit of Corn.

But now,

	Avocado	Corn
Canada	1 (6/1 = 6)	6 (1/6 = 0.17)

But now Canada has to give up only 0.17 units of Avocado to produce a unit of Corn.

Hence, Californians: are they better off.