Question

A nation that decides to specialize and trade will not be limited to the options shown by its own pre-trade PP curve. That is, the trading or consumption possibilities curve, which shows the combination of the two goods consumed will be different after trade and specialization (compared to autarkic situation.) Draw 1) the production possibilities curve for each country; 2) the consumption possibilities curves for each country; and 3) locate the final production point for each country. [Hint: It is not necessary to use numbers when drawing the consumption/Trading possibility curves. Why? Because there are so infinite of them. It is possible to use numbers as long as you are using a trade (barter) price that is strictly between the upper bound and lower bound of the exchange price. See how I did it in the worked-out examples- Absolute and Comparative advantage, for example.]

Shirtland Possibilities
Point	Shirts	Chips
r	108	0
h	54	18
s	24	28
t	0	36

Chipland Possibilities
Point	Shirts	Chips
b	120	0
c	60	60
d	0	120

Answer 1

a. From the given table, PPF curves for Shirtland and Chipland are drawn below:

b. From the given information , we can say that, Chipland has absolute advantage in production of both the goods.

However, opportunity cost of producing shirts for Shirtland = 36/108 = 0.33 and that for Chipland = 120/120=1. As opportunity cost of producing shirt is lower for Shirtland , It has comparative advantage in production of shirts.

Similarly, opportunity cost of producing chips for Shirtland = 108/36 = 3 and that for Chipland = 120/120 =1. As opportunity cost of producing chips is lower for Chipland, it has comparative advantage in the production of chips.

As a result the two countries may trade such that Shirtland only produces and export shirts and import chips whereas, Chipland only produces and export chips and imports shirts.

Thus, for trade, we have shown the possible consumption possibility frontier curves as shown below:

c. The relative world price lies in between (P_shirt/P_chip)^autarkyfor Shirtland < (P_shirt/P_chip)for world < (P_shirt/P_chip)^autarky for Chipland i.e, 0.33 < (P_shirt/P_chip) world < 1.

Suppose the relative world price be 0.5 or, I unit of shirt will be exchanged for 0.5 unit of chip.

Then, if Shirtland produces 108 units of shirt, it will consume 54 units and sell the remaining 54 units. In exchange it will get 54*0.5 =27 units of chips from Chipland. Similarly , if Chipland produces 120 units of chips , it will sell 27 units of chips and consume 93 units of chips. In return it gets 54 units of shirts.