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This question will ask you to analyse economic effects by applying the Ricardian model,Use the Ricardian model analyse economic effects of by Ricardian model between  two production goods: tomatoes and paper. In Sweden, it takes 10 hours to produce a kilo of paper, and 3 hours to produce a kilo of tomatoes. Under free trade before , the world relative price of paper in terms of tomatoes was 10.

a) Under free trade, what good or goods does Sweden produce? What does it export? Explain your answer.

b) Under free trade, draw the production possibility frontier (PPF) and consumption possibility frontier (CPF). Explain your answer.

c) Under free trade, show how much of each good a worker can consume. Explain your answer.

d) Now, assume that the effect of the Corona virus is that Sweden can no longer trade with the rest of the world. What is the consumption possibility frontier (CPF) of Sweden in this case? Explain your answer.

e) Under autarky, how much of each good can a worker consume? Explain your answer.

Answer 1

In Sweden, a kilo of paper takes 10 hours to produce whereas, a kilo of tomatoes takes 3 hours to produce.

Then, in Sweden, opportunity cost of producing paper = 10/3 = 3.33 tomatoes and opportunity cost of producing tomatoes = 3/10 = 0.3 paper

The world relative price of paper (opportunity cost of producing paper in the world market) = 10 tomatoes.

a) Under free trade, Sweden has comparative advantage in the production of paper (opportunity cost of producing paper is lower for Sweden) . Thus, it must specialize and export paper.

b) Suppose Sweden has x labor hours. Then, it can produce x/10 kilos of paper and x/3 kilos of tomatoes.

Let, before trade , Sweden was producing x/20 kilos of paper and x/6 kilos of tomatoes (point A).

Now, under free trade, Sweden will produce x/10 kilos of paper only. Then, it can consume x/20 kilos of paper and export remaining x/20 kilos of paper to the rest of the world. In exchange, Sweden will gain x/20*10 = x/2 tomatoes (point B).

Here, we have shown PPF and CPF for Sweden :

c) Under free trade, each worker can consume at point B (i.e, 1/20 kilos of paper and 1/2 kilos of tomatoes) .

d) Due to pandemic, CPF of Sweden gets shifted to its PPF. New consumption level is point A.

e) Under autarky, each worker can consume at point A (i.e, 1/20 kilos of paper and 1/6 kilos of tomatoes) .