Question

3. The following table describes the production possibilities of two cities in the country of Baseballia: (12 points)

Pairs of Red Socks per Worker per Hour

Pairs of White Socks per Worker per hour

Boston

3

3

Chicago

2

1

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a. Without trade, what is the price of white socks (in terms of red socks) in Boston?

Answer:

b. Without trade, what is the price of white socks (in terms of red socks) in Chicago?

Answer:

c. If the cities trade with each other, which color sock will each export?

Answer:

d. What is the range of prices at which trade can occur?

?Answer:

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Answer 1

Solution-

a. Without trade, what is the price of white socks (in terms of red socks) in Boston?

From the table we see that 1 worker-hour (1 worker working for 1 hour) employed in the production of white socks is necessary to produce 3 pairs of white socks in Boston. If this worker-hour was employed instead in producing red socks, exactly 3 pairs of red socks would be produced. Thus the price of 3 pairs of white socks is just 3 pairs of red socks -- or equivalently -- the price of one pair of white socks is one pair of red socks.

b. Without trade, what is the price of white socks (in terms of red socks) in Chicago?

Similarly, in Chicago, freeing up 1 worker-hour from producing 1 pair of white socks and employing it instead in red socks production, 2 pairs of red socks can be produced. Thus, the price of 1 pair of white socks is 2 pairs of red socks, or equivalently, the price of a pair of white socks is two pairs of red socks.

c. If the cities trade with each other, which color sock will each export?

When opened up to trade, each city will specialize in the production of the good in whose production it has a comparative advantage, and will export that same good. Thus Boston will export white socks and Chicago will export red socks.

d. What is the range of prices at which trade can occur?

A city will remain no worse-off from trade if its terms of trade (the ratio of the price of the exported good to the price of the imported good) are higher than or equal to the ratio of the domestic prices of the same two goods before opening up to trade. If the terms of trade do not meet this condition for either or both of a pair of cities, the city for which this is not met will prefer not to trade since it will be better off without trade. In such a situation, mutually agreeable trade cannot take place.

Therefore, Boston – who will export white socks -- will only agree to trade if the price of white socks is more than or equal to 1 pair of red socks. Similarly, Chicago – who will import white socks – will only agree to trade if the price of white socks is less than or equal to 2 pairs of red socks. Thus, the range of prices at which trade can occur is when the price of a pair of white socks is between 1 and 2 pairs of red socks inclusive, ie. 1 pair red socks ? price of 1 pair white socks ? 2 pairs red socks.