Question

1. Assume that aircraft production is capital intensive and that apparel production is labour intensive. Sketch Countries A and B’s production possibilities frontiers for aircraft and apparel. Explain why you drew them as you did? (10 points)

2. If tastes for aircraft and apparel are identical in both countries a. Which country has a comparative advantage in which good? Explain how you know. (10 points)

b. Illustrate the autarky and the free-trade equilibria for the two countries (10 points)

3. What happens to the relative price of aircraft and apparel in each country when they open to trade? Explain! (10 points)

4. Assume that after opening to trade, Country A experiences a significant decrease in its labour endowment. Explain what would be the impact of that change on the equilibrium relative price of aircraft. (10 points).

Answer 1

An increase in the endowment of a factor results in a bigger increase if the output of the industry is more intensive suppose labor intensive or capital intensive as mentioned above. The other industry's output decreases as a result. Production possibility curve shows the possibility based on two main factors technology and resources.

Country A has a better capability in producing aircraft than country B. Similarly in case of apparel country B has a better capability in producing apparel.

2. If tastes and preference in both the goods that is aircraft and apparel are identical in both the countries. If we talk in terms of trade, then capital is relatively cheap in capital intensive economy that is country A and similarly labor is relatively cheal in labour intensive economy that is country B.

It is clear from the statement that because of the relative differences in the economy of capital and labour both the economy have different advantage.

1. Country A would have relative advantage of producing aircraft than economy of country B.

2. Country B would have relative advantage of producing apparel than country A.

2.b In case of autarky, both country have the same demand for both the commodity. It is signified through point(marginal rate of trade) in the diagram.

3. If they open free trade real wages will never lower the free trade in labor intensive capital allowing its specialization. In respect to overall relative differences between their intensive factors. The labor intensive country will produce and export it to the capital rich economy. But in case of capital intensive economy, it will produce with the same capital intensity that prevails in the capital intensive country. However, the Marginal product of its labor will be same as in labor endowment despite of having more labor endowment.