Question

 

Q-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 Corona virus occurred, 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

a) Sweden can take 10 hours to produce a kilo of paper and 3 hours to produce a kilo of tomatoes. Then, Sweden can produce 2.4 kilos of paper or 8 kilos of tomatoes in 24 hours. Relative price in Sweden (opportunity cost of producing paper) is 8/2.4 = 3.3 tomatoes per paper.

World relative price is 10 tomatoes per paper.

Here, Sweden has comparative advantage in the production of paper (as relative price of paper is lower for Sweden). Thus, Sweden must specialize and export papers under trade.

b)

In the diagram below, we have shown the PPF and CPF for Sweden, considering trade takes place at an exchange rate of 5 tomatoes per paper.

c) In the above situation, if Sweden produces only paper (2.4 kilos of paper), then, it can consume 1.2 kilos of it and trade the remaining amount (1.2 kilos of paper). In this case. Sweden gains 1.2*5 = 6 kilos of tomatoes. Thus, Sweden gains 2 tomatoes from trade.

d) Due to coronavirus outbreak, the CPF shifts back to the PPF for Sweden with no trade. Here, Sweden will consume 1.2 kilos of paper and 4 kilos of paper.

e) Under autarky, workers can consume at any point on its PPF.