Question

[3] The Home country has 2,200 units of labor available while the Foreign country has 1600 units of labor. The two countries produce two goods, textiles and soybeans. The unit labor requirements in textile production for the Home and Foreign countries is 7 and 2.5, respectively, while soybean production requirements is respectively 3 and 5.

a.) Graph the Home and Foreign production possibilities frontiers.

b.) What is the opportunity cost of textiles in terms of soybeans for both countries?

c.) What is the opportunity cost of soybeans in terms of textiles for both countries?

d.) What will be the no trade Terms of Trade (or PS/PT) for each country?

e.) How will the Terms of Trade (or PS/PT) change for each country if they trade?

d.) Show the trade triangles for the two trading countries.

Answer 1

Home country has 2,200 units of labor available. Home country requires 7 labors and 3 labors for one unit production of textile and soybean respectively. Thus, home can produce 314 units of textile or 733 units of soybean. Plotting textile on vertical axis and soybeans on horizontal axis, PPF for home has a vertical intercept of 314 and a horizontal intercept of 733.

Foreign country has 1,600 units of labor available. Foreign country requires 2.5 labors and 5 labors for one unit production of textile and soybean respectively. Thus, foreign can produce 640 units of textile or 320 units of soybean. Plotting textile on vertical axis and soybeans on horizontal axis, PPF for foreign has a vertical intercept of 640 and a horizontal intercept of 320.

a) In the diagram below, we have shown PPF for both the countries:

b) Opportunity cost of producing textiles in home = Units of soybeans sacrificed/Units of textiles produced = 733/314 = 2.33 soybeans

Opportunity cost of producing textiles in foreign = Units of soybeans sacrificed/Units of textiles produced = 320/640 = 0.5 soybeans

c) Opportunity cost of producing soybeans in home = Units of textiles sacrificed/Units of soybeans produced = 314/733 = 0.43 textiles

Opportunity cost of producing soybeans in foreign = Units of textiles sacrificed/Units of soybeans produced = 640/320 = 2 textiles

d) No terms of trade for home when exchange rate for trade is smaller than its P_s/P_t (0.43)

No terms of trade for home when exchange rate for trade is greater than its P_s/P_t (2)

e) Terms of trade must lie in the range : relative price in home (P_s/P_t) < TOT < relative price in foreign (P_s/P_t)

or, 0.43 < TOT < 2

f) We can show trade triangle for both countries considering that world exchange rate is 1 unit of textile per unit of soybean.