Question

Consider a Ricardian world consisting of U.S. and Japan. Both countries produce and consume the same two goods: cars and computers. In U.S., it takes 400 hours of labor to make a car, and 100 hours of labor to make a computer. In Japan, it takes 400 hours of labor to make a car, and 200 hours of labor to make a computer. Each country has 2 billion hours of labor.

            a. What would the autarky equilibrium (i.e., the amount of each good produced and consumed as well as the relative price of each good) in these two countries be if each devotes 80% of its labor force to the production of cars and the rest to the production of computers? Show the autarky equilibrium for each country in a graph with the respective numbers on the graph.

            b. Which country has absolute advantage in cars? In computers? Why?

            c. Given the answer to b, would U.S. have any incentive to trade with Japan? Who has comparative advantage in what? Why?

            d. If there is free trade, what would the world relative price of a car be if both countries produce cars?

            e. If there is free trade, what would the wages in Japan relative to the wages in U.S. be if both countries completely specialize?

            f. Suppose there is free trade and the world demand for cars exceeds 5 million. Who would produce what? What would the U.S.'s commodity terms of trade be? What would the Japan's commodity terms of trade be? Which country would be `small'? Explain.

You can do the graphs by hand but your explanation/text has to be typed.

Answer 1

Answer:

For each country,

Hours devoted to cars = 2 billion x 80% = 1,600 million

Hours devoted to computers = 2 billion x 20% = 400 million

b. Which country has absolute advantage in cars? In computers? Why?

There will be absolute advantage of no country as the number of hours required by both the country are same ( 100 hours) for producing each car. In computer production, US have the absolute advantage as it takes only 25 hours against 50 hours of Japan.

            c. Given the answer to b, would U.S. have any incentive to trade with Japan? Who has comparative advantage in what? Why?

). The United States has a comparative advantage in producing computers (1/4 hours of producing a car).

When it comes to absolute advantage, there will be no incentive for USA to trade with Japan but when it comes to comparative advantage, the USA will have incentive to trade with Japan in case of computers as Japan has the comparative advantage in the production of cars ( 2 hours of producing a computer). The comparative advantage of USA is in computers ( 0.25 hours in car production)

            d. If there is free trade, what would the world relative price of a car be if both countries completely specialize?

The world relative price of producing a car would be between 2 and 4 hours of producing a computer.

            e. If there is free trade, what would the wages in Japan relative to the wages in U.S. be if both countries produce cars?

The wages in Japan relative to the wages in the US would be 1 if both countries produce cars. = 1

            f. Suppose there is free trade and the world demand for computers exceeds 80 million. Who would produce what? What would the U.S.'s commodity terms of trade be? What would the Japan's commodity terms of trade be? Which country would be `small'? Explain.

When the word demand is more than 80 million, the all the available 80 million hours of Japan will be utilized but in case of USA , the rest hours will be added by it. The commodity trade terms will be 0.5 hours of car production for USA and for Japan , it will be 2 hours of car production. The USA will be treated as small as it is not capable of affecting the world price.