Question

Suppose Home has 2,000 units of labor available. It can produce two goods, clothing (C) and wheat (W). The unit labor requirement in clothing production is 5, while in wheat production it is 2. Home is as described above. Now suppose there is another country, Foreign, with a labor force of 3,000. Foreign’s unit labor requirement in clothing production is 2, while in wheat production it is 4.

a. Which country has an absolute advantage over the other in clothing production? Which has a comparative advantage over the other in wheat production?

b. What and how much do Home and Foreign produce, respectively, when the world relative price of clothing is 0.5, i.e., pC/pF = 0.5?

c. What is the range for the relative price of clothing under free trade?

d. Suppose the world relative price of clothing under free trade is 2, i.e., pC/pF = 2. Describe the pattern of trade between Home and Foreign?

e. Show that both Home and Foreign gain from trade at pC/pF = 2?

Answer 1

a) Let represent unit labor requirement in clothing production in Home country. as per the question. Let represent unit labor requirement in wheat production in Home country. as per the question. Let represent unit labor requirement in clothing production in Foreign country. as per the question. Let represent unit labor requirement in wheat production in Foreign country. as per the question.

As unit labor requirement in clothing production in Foreign country i.e. is lesser than unit labor requirement in clothing production in Home country i.e. , so foreign country has absolute advantage over home in clothing production. Opportunity cost of wheat production relative to clothing production in Home is

Opportunity cost of wheat production relative to clothing production in Foreign is

As opportunity cost of wheat production relative to clothing production in Home is lesser than opportunity cost of wheat production relative to clothing production in Foreign this imply home country have comparative advantage over foreign in wheat production.

b) When world relative price of clothing is ----------------------------

Opportunity cost of clothing production relative to wheat production in Home is

Opportunity cost of clothing production relative to wheat production in Foreign is

As opportunity cost of clothing production relative to wheat production in foreign is less than that in home so foreign will specialize in production of clothing whenever .

Now as     so, imply Foreign country will provide any positive relative amount of clothing and wheat while Home will not produce anything as .

c) Range of relative price of clothing in free trade is in this case is as foreign has comparative advantage in clothing and home has comparative advantage in wheat.

d)  When world relative price of clothing is ----------------------------

Then which means each country will specialize in production of good in which it has comparative advantage and trade it for other good. Foreign specializes in clothing production , home specializes in wheat production therefore, Foreign country will export clothing to Home country and import wheat from Home country while Home export wheat to foreign country and import clothing from foreign country.