Question

Consider a country, Home, populated by a labor force of 90 workers. The country can produce two goods, Apples and Bananas. Labor is the only factor of production and it can freely move across sectors. It takes 1/2 unit of labor to produce one Apple; similarly, and it takes 1/2 unit of labor to produce a Banana.

Now consider another country, Foreign. Unit labor requirements are as follows: 1 4 unit of labor per Apple, 1 6 unit of labor per Banana. Labor force is 60 workers.

1. Assume that the international price in equilibrium is pA/pB = 1.25. At this relative price how many Apples and Bananas does Home produce? How many Apples and Bananas does Foreign produce? Is there complete or incomplete specialization?

2. Draw initial PPF (Production Possibility Frontier) for the Home country. Indicate on this graph the production point for Home. Also indicate qualitatively where the consumption point under trade is for the Home country. Is the Home country better off (i.e. can it consume more of both goods) under trade?

3. Do the same as above (part 2) for Foreign country. Is it better off?

Answer 1

Answer :

unit labour requirement  

now opportunity cost of produce of A in home

=   

= 1B

opportunity cost of A in foreign =

so lower opportunity cost of A in H , so H has comparative advantage in A

F has comparative advantage in B

1)

equilibrium relative price intersect RS at vertical segment , so

home produce only A =180

F produce only B = 360

yes competitive specialization

	A	B	L
home			90
F			60

2) Production possibility Frontier of H , A +B = 180 (let A on X axis , B on y axis )

as TOT , 1A could be exchanged for 1.25 B , then , production point , ( A, B )² = (180, 0)

let if 90 A is exchanged for 90 * 1.25 = 112.5

thus this point lies outside of ppf and home is better off.

3) For foreign , max B= 360 , max A =240.

PPF slope = = 1.5

at = 1.25, (A , B )^F = (0 , 360)

now exchange 112.5 B for 90A , lies outside ppf

Hence better off.

now (A,B)^f = (B = 247.5)

(A = 90)