Question

I only need D E and F answered I have completed the rest

Consider two countries: Canada (CAN) and Iceland (ICE). Two goods can be produced: gloves (g) and socks (s). Goods are produced only using labour, and the unit labour requirements of the two goods in each country are given in the following table:

??????= 2	??????= 8
??????= 3	??????= 6

Assume that Canada has 3000 units of labour, while Iceland has 1500 units of labour. When setting up any diagrams, express everything in terms of gloves, relative to socks. For example, the RS-RD curves should be expressed in relative quantities and prices of gloves (relative to socks).

1. a) Who has a comparative advantage in each good? Why? Show your calculations, if any are needed.
2. b) Assume that, under free trade, the RD curve intersects the RS curve where the relative price of gloves equals 1/3. Draw a fully labelled RS-RD curve diagram, which clearly labels each curve and also the height of each “step” in the RS curve on the y-axis, as well as the relative quantity at which the vertical portion of the RS curve lies.
3. c) Calculate what the relative wages (Canada’s wages divided by Iceland’s wages) would be, after opening up to trade as in part b). (Note: you have all the information needed to do this part; you do not need the specific prices of each good!).
4. d) Draw a PPF and an expanded consumption possibilities curve, as in lecture, to show how Canada gains from opening up to trade in part 2b). Please draw a diagram, but also briefly explain in words how Canada gains from trade.
5. e) Because of research and development, Iceland’s unit labour requirement in gloves improves to a new value of 1.5. Calculate/describe what happens to the following: a) comparative advantages, b) the RS curve, c) any gains from trade for Canada, assuming the same RD curve in part 2b). Be sure to actually draw and label the new RS curve.
6. f) Ignore any changes from f). Assume that both countries experience a doubling of labour; Canada now has 6000 units of labour and Iceland has 3000. Provide 3 diagrams: 1) a diagram showing Canada’s PPF pre and post change, 2) a diagram showing Iceland’s PPF pre and post change, and 3) the RS curve in terms of gloves pre and post change. If there are any curves that you do not think have changed or shifted, please indicate that this is the case in your diagram and explain why. Also briefly describe what happens to the pattern of trade between Canada and Iceland if the RD curve has not shifted from the one given in 2b).

Answer 1

Canada has 3000 units of labor. If all labor is used in production of gloves, amount of gloves = 3000/2 = 1500 and if all labor is used in production of socks, amount of socks = 3000/8 = 375.

Iceland has 1500 units of labor. If all labor is used in the production of gloves, amount of gloves = 1500/3 = 500 and if all labor is used in production of socks, amount of socks = 1500/6 = 250.

Opportunity cost of producing gloves for Canada is 375/1500 = 0.25 and that for Iceland is 250/500 = 0.5. As opportunity cost for producing gloves is lower for Canada , it has comparative advantage in production of gloves.

Opportunity cost of producing socks for Canada is 1500/375 = 4 and that for Iceland is 500/250=2. As opportunity cost for producing socks is lower for Iceland, it has comparative advantage in production.

Now, for trade Canada will produce 1500 units of gloves and Iceland will produce 250 units of socks.

From the output values calculated above, PPF curves for both countries can be drawn as follows:

Now , if due to technology , Iceland's unit labor requirement for gloves becomes 1.5, then with all labor Iceland can produce 1500/1.5 = 1000 units. Then opportunity cost for gloves in Iceland = 250/1000 = 0.25 and that for socks in Iceland = 1000/250 = 4. Hence, opportunity costs for Iceland becomes equal to that for Canada.

Thus, no country will specialize in production of single item and trade is not beneficial in this condition.