[One-factor model] Assume that there are 2 countries: Home and Foreign. And there are 2 goods:...

[One-factor model] Assume that there are 2 countries: Home and Foreign. And there are 2 goods: apple and banana. Home has 2,400 units of labor available. The unit labor requirement in apple production is 6, while in banana production it is 4. Foreign has 800 units of labor available. The unit labor requirement in apple production is 5, while in banana production it is 1.

1) What is the opportunity cost of apples in terms of bananas in Home and Foreign?

2) In the absence of trade, what would be the price of apples in terms of bananas in Home and Foreign? Why?

3) Graph the production possibility frontiers for Home and Foreign.

4) Construct the world relative supply curve.

5) Suppose that world relative demand takes the following form: Demand for apples/demand for bananas = price of bananas/price of apples. Graph the relative demand curve along with the relative supply curve.

6) What is the equilibrium relative price of apples?

7) Describe the pattern of trade.

8) Show that both Home and Foreign gain from trade.

Solutions

Expert Solution

1) Home:

1 Apple takes 6 labour units

1 Banana takes 4 labour units

Therefore the oopurtunity cost of one apple would be = 6/4 = 1.5 bananas in Home

Foreign:

1 Apple takes 5 labour units

1 banana takes 1 labour unit

In this case, 1 apple will have oppurtunity cost of = 5/1 = 5 bananas in foreign

2.) In absence of trade, the oppurtunity cost will be the price of apples in terms of bananas

Home: 1 apple will cost 1.5 bananas

Foreign: 1 apple will cost 5 bananas

This is because in absence of trade, apples and bananas are produced from the labour units of each individual country and there is not outside or trade influence on prices and demand. The hours or labour units spent on apples and bananas will act as the currency for their pricing.

3.)

4.) The world supply curve would be step shaped with the step occuring at the prices of apples from 1.5 bananas to 5 bananas:

Rahul Sunny answered 1 year ago

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