Question

Consider the following Ricardian model of world trade. There are 2 goods, Beer (B) and Pretzels...

Consider the following Ricardian model of world trade. There are 2 goods, Beer (B) and Pretzels (P), and 2 countries, Home and Foreign. Assume each country has the same preferences, and technologies are such that:

HOME: 1 unit of B requires 2 units of labor; 1 unit of P requires 18 units of labor

FOREIGN: 1 unit of B requires 3 units of labor; 1 unit of P requires 5 units of labor.

A. If trade is introduced between these two countries, what will be the pattern of production and exchange as predicted by the Ricardian model? Explain the answer.

B.      The free trade relative price of beer in terms of pretzels will be greater than or equal to _______ and less than or equal to _______.

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Homework Answers

Answer #1

The countries will produce according to the comparative advantage as follows:

The opportunity cost of producing B at home = 2/18 = 1/9 units of P

The opportunity cost of producing P at home = 18/2 = 9 units of B

The opportunity cost of producing B at foreign = 3/5 = units of P

The opportunity cost of producing P at foreign = 5/3 units of B

(A) Since the opportunity cost of producing B at home is lower than the opportunity cost of producing B at foreign, Home has a comparative advantage in production of B and it will produce and export B to foreign

Since the opportunity cost of producing P at foreign is lower than the opportunity cost of producing P at home, Foreign has a comparative advantage in production of P and it will produce and export P to home.

(B) The free tarde price of beer in terms of pretzels will be greater than or equal to 1/9 and less than equal to 3/5

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