Question

The world economy consists of two regions, North and South, and two goods, manufacturing (good 1) and agriculture (good 2). In North, producing one unit of manufacturing good requires two units of labor while producing one unit of agricultural good requires one unit of labor. In South, producing one unit of manufacturing good requires five units of labor while producing one unit of agricultural good requires one unit of labor. North has 100 units of labor and South has 150 units of labor. World relative demand for manufacturing good to agricultural good is RD= (C1+C1^*)/(C2+C2^* )=(P1/P2 )^(-1) where C1 and C2 are consumption of manufacturing and agricultural goods in the North, C1^* and C2^* are consumption of manufacturing and agricultural goods in the South, and P1 and P2 are world prices of manufacturing and agricultural goods.

b).Construct the equations and graphs of consumption possibility frontier for North under the cases of closed economy and free trade. Determine the maximum amount of consumption of agricultural good and of manufacturing good for North in closed economy and under free trade. Where does the free trade relative price of agricultural good to manufacturing good appear in the equations describing consumption possibility frontiers?

c). Does the North gain from trade? Explain.

Answer 1

SO, in the fig we can see that in the auterkic situation the maximum production and consumption of "C2=agricultural good" was "OA1" but under free trade the maximum consumption of "C2" increased to "OA2" > "OA1", on the other hand at "A1" the consumption of "C1" was zero" ,but under free trade it increased to "AD", so here we can consider "A1D" as a gain from trade for North.