Question

Suppose that there are two countries; Country 1 and Country 2. Country 1 is capital abundant and country 2 is labor abundant. X is capital intensive and Y is labor intensive. Assume that Country 1 is a large country and country 2 is a small country.

Answer the following questions:

a) Suppose that Country I's capital stock increases. Show the pregrowth and after growth production and consumption points on a figure. Clearly explain how the production and consumption of commodity X and Y would change after growth.

b) What happens to the terms of trade of Country 1, terms of trade of Country 2, welfare of country 1 and country 2 when Country I's capital stock increases?

c) Now, suppose that Country 2's labor supply increases. (You start from the original question) Show the pregrowth and after growth production and consumption points on a figure. Clearly explain how the production and consumption of commodity X and Y would change after growth if we assume that both X and Y are normal goods.

Answer 1

a.

Suppose country 1s capital stock increases country will specialise in the production of commodity X. Because commodity X is capital intensive as a result production possibility Frontier shift support towards this x axis. As a result they will produce more of commodity x and will move from point a to point B.at the consumption will also increase.

 

b.

Suppose if there is an increase in the capital in country one country one will produce more of commodity X. Because commodity X is capital intensive commodity. As a result the demand for capital will increase and therefore the price of capital will also increase could stop as a result the terms of trade will be favourable to country one. Because terms of trade is the price ratio of exporter commodity to the important commodity. If the demand for capital increases capital price will also increase as a result the terms of trade will improve for country one and it wasn't for country 2. As a result there will be a fall in the Welfare in country to and increase in the Welfare and country one.

 

c.

Suppose it country to is a labour abandoned country and commodity y is the labour intensive commodity if there is an increase in the labour it will lead to an increase in the production of labour intensive commodity commodity y. As a result of a possibility Frontier will shift upwards and the country will produce more of commodity white and it will be able to move from point C to Point D.