Question

1. Table 1 given below shows the number of labor hours required to produce 1 bushel of wheat and 1 ton of iron in Russia and North Korea.

Table 1

Labor hours to make:	In North Korea	In Russia
1 bushel of wheat	4	1
1 ton of iron	10	5

You make several Ricardian assumptions: these are the only two commodities, the productivity of labor is constant for each product no matter how much is produced, and competition prevails in all markets.

1. Compute the productivity of each country for each product. Which country has an absolute advantage at producing wheat? Which country has an absolute advantage at producing iron?  

2. Compute the relative prices of each product in each country without trade.    Which country has a comparative advantage at producing wheat? Which country has a comparative advantage at producing iron?  

3. According to the theory of comparative advantage, which country would export wheat? Which country would export iron?  

If Russia and North Korea are allowed to trade, between what prices would the international relative price of iron be? Between what prices would the international relative price of wheat be?  

Please show work and step by step explanation. Thanks!

Answer 1

(a)

Productivity table (productivity = number of units produced in one hour) as follows.

	N. Korea	Russia
Wheat	1/4 = 0.25	1/1 = 1
Iron	1/10 = 0.1	1/5 = 0.2

Since Russia has higher productivity in wheat than N. Korea has (1 > 0.25) and higher productivity in iron than N. Korea has (0.2 > 0.1), Russia has absolute advantage in both wheat and iron.

(b)

Relative price (RP) is computed as follows.

In N. Korea,

RP of wheat = 0.1/0.25 = 0.4 iron

RP of iron = 0.25/0.1 = 2.5 wheat

In Russia,

RP of wheat = 0.2/1 = 0.2 iron

RP of iron = 1/0.2 = 5 wheat

Since Russia can produce wheat at lower RP than N. Korea can (0.2 < 0.4), Russia has comparative advantage in wheat.

Since N. Korea can produce iron at lower RP than Russia can (2.5 < 5), N. Korea has comparative advantage in iron.

(c)

According to comparative advantage, Russia will export wheat and N. Korea will export iron.

(d)

For trade to be mutually beneficial, after-trade relative price has to lie between pre-trade RP in both trading parties.

Acceptable after-trade RP are:

2.5 wheat < RP of iron < 5 wheat, and equivalently,

0.2 iron < RP of wheat < 0.4 iron.