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Assume that Home can produce two goods, apples and bananas. The unit labor requirement in apple production is 4, while it is 2 in banana production. Foreign’s unit labor requirement for apples is 8 and it is 2 for bananas. Assume that when these countries trade, Home specializes in apples, Foreign specializes in bananas and the world relative price of apples (PA/PB) = 2.

a. If these countries trade, which country will have a higher wage? Why is this the case?

b. Using a numerical example for prices, show how wages are derived in each country when they trade with each other.

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1 Feb 2019

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Exercise 3

Assume there are two countries, Home and Foreign. Home has 1000 labor hours available. It can produce two goods, apples and bananas. The unit labor requirement in apple production is 2, while in banana production is 4. Foreign has 600 labor hours available. Foreign’s unit labor requirement in apple production is 5, while in banana production it is 1.

(a) Construct the world relative supply curve. [Note: on the horizontal axis there is（ QA+QA*/QB+QB* ）and on the vertical axis there is （PA/PB）]

(b) Draw the two possible demand curves and identify the possible equilibria.

(c) Identify the “normal outcome of trade,” state what each country produces in correspondence of the “normal outcome of trade” (including the reason behind your statement).

Home Apple alA=0.8 Banana alB=0.5

Foreign Apple a ∗ LA = 1 a ∗ LB = 0.5

Problem 2. (50 points) Now, Home and Foreign trade with each other. Suppose that the world’s

equilibrium relative price of apple is 1.8. That is one apple can trade for 1.8 banana. Then answer

the following questions:

8.In which economy can labor earn a higher wage? Explain based on your calculation of the relative wage W/W∗ . (10 pts)

Use the following information for the next seventeen questions:

Assume that it takes the US 150 units of labor to produce a table and 30 units of labor to produce a chair.

Assume it takes the Netherlands 100 units of labor to produce a table and 10 units of labor to produce a chair.

Assume that each country has 4800 units of labor and before trade, each country splits their labor evenly between chair and table production.

Assume that when the countries decide to trade, the country specializing in table production specializes in table production only.

Assume that when the countries decide to trade, the country that specializes in chair production uses 1000 units of labor for table production and the rest (3800 units) for chair production.

Assume that when the countries trade, there are a total of 15 tables traded at a rate of 7 chairs per table.

1. What is the opportunity cost for the US for the production of one chair in terms of number of tables?

Hint: enter a number only, do not write tables after the number and if the number is a fraction, enter it as a decimal

Example: if the answer is 8 tables, enter 8 or if the answer is 1/4 tables, enter 0.25.

2. What is the opportunity cost for the Netherlands for the production of one table in terms of number of chairs?

Hint: enter a number only, do not write chairs after the number and if the number is a fraction, enter it as a decimal

Example: if the answer is 8 chairs, enter 8 or if the answer is 1/4 chairs, enter 0.25.

3. Who has the comparative advantage in table production?

4. Who has the comparative advantage in chair production?

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