Question

There are two goods: food F and clothing C. MRS is the marginal rate of substitution, and RPT is the rate of product transformation.

a) in Fredonia in autarky, MRS=6F/C and in Sylvania in autarky MRS*=2F/C. Specify a trade which makes both countries better off.

b) in Gargantua in autarky RPT=4F/C and in Lilliput in autarky RPT*=10F/C. Specify a reallocation of production across countries such that the output of both goods rise.

Answer 1

a).

Consider the given problem here there are two goods “F=food” and “C=clothing”. In the autarkic situation the MRS is exactly equal to the opportunity cost. If we compare the MRS of two country then we get that the MRS of Sylvania is less than the same for Florida, => Sylvania having lower opportunity cost producing cloth compare to Fredonia. So, under the free trade situation Sylvania will export cloth in exchange of food and Fredonia will export food in exchange of cloth.

The above fig shows the economy of Sylvania where “E1” be the autarkic equilibrium and as the relative price increase the country become better off.

The above fig shows the economy of Fredonia where “E1” be the autarkic equilibrium and as the relative price decrease the country become better off.

b).

Consider the given problem here there are two goods “F=food” and “C=clothing”. The RPT is exactly equal to the opportunity cost. If we compare the RPT of two countries then we get that the RPT of Gargantua is less than the same for Lilliput, => Gargantua having lower opportunity cost producing cloth compare to Lilliput. So, under the free trade situation Gargantua will export cloth in exchange of food and Lilliput will export food in exchange of cloth.

The above fig shows the economy of Garganta and Lilliput. So, initially total production of food was “FG1+FL1” later it increases to “FG2+FL2”, => total production of food increases. Similarly, initially total production of clothing was “CG1+CL1” later it increases to “CG2+CL2”, => total production of clothing increases. So, the production of both good increases.