It requires 5 hours of labor to produce a ton of Steel in Italy and 3...

It requires 5 hours of labor to produce a ton of Steel in Italy and 3 hours in China, and it requires 20 hours of labor to produce a car in Italy and 15 hours in China.

1. Construct a production possibilities curve for each country.

2. If Italy and China were the only countries involved in trade, what would be the pattern of trade between them? Assume 100 hours of labor are available in each country.

Expert Solution

Take 100 labor hours in both nations.

It requires 5 hours of labor to produce a ton of Steel in Italy and 3 hours in China. With each country having 100 hours of labor, Italy would be producing 100/5 = 20 tons of steel while China would be producing 100/3 = 33.33 tons of steel.

It requires 20 hours of labor to produce a car in Italy and 15 hours in China. With each country having 100 hours of labor, Italy would be producing 100/20 = 5 cars while China would be producing 100/15 = 6.67 cars

1) PPF is drawn below assuming 100 labor hours.

2) Opportunity cost of producing 1 car is 33.33/6.67 = 5 tons of steel while the same is 20/5 = 4 tons of steel. Hence this cost is lower for Italy and thus, Italy has a comparative advantage in production of cars. Similarly, China has a comparative advantage in production of steel. If countries specialize in these activities and trade with each other, China would produce (33.33 tons) and export steel while Italy would produce (5 units) and export cars. The terms of trade would then lie between the opportunity costs (price of 1 car would lie between 4 tons of steel and 5 tons of steel)

Rahul Sunny answered 2 years ago

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