Question

Consider a Ricardian model. There are two countries called Australia and New Zealand and two goods called beer and cheese. In Australia the unit labour requirement for a beer is 10 hours and for a cheese is 10 hours. In New Zealand the unit labour requirement for a beer is 4 hour and for a cheese is 1 hour. Australia has an endowment of 2000 hours of labour. New Zealand has an endowment of 400 hours of labour.

1 Draw a production possibility frontier (PPF) diagram for Australia and a PPF diagram for New Zealand. Cheese must be on the vertical axis and beer must be on the horizontal axis.

2 For both countries state the opportunity cost of producing a beer.

3 Suppose now that we have trade between the countries and the world price is 2 cheeses for 1 beer. For each country draw in the budget constraint. For each country label the production point on the diagram.

4 Denote the world prices in dollars as PB and PC respectively. Denote the respective quantities of beer and cheese consumed in New Zealand (following trade, of course) as DB and DC . Using this notation, write out an expression for the value of consumption in New Zealand. [Just a one-line answer]

5 Write out the budget constraint for New Zealand. That is, set the value of consumption equal to the value of production. [Again just a one-line answer]

6 Rearrange the budget constraint, showing all the steps, so that DC is on the left-hand side and everything else is on the right-hand side so the vertical intercept and slope are apparent. [Please see the next page]

7 While the ratio of prices is apparent from Question 3, we will assume from here on that PC=$1 and PB=$2. If 100 beers are consumed in New Zealand, how many cheeses will be consumed in New Zealand? Now if only 50 beers are consumed, how many more cheeses will be consumed?

8 For both countries calculate the hourly wage rate once international trade is allowed to take place (obviously for each country there can only be one wage rate in this model).

Answer 1