02 Jun Question 1. There are two countries, Home and Foreign, wh
Question
1. There are two countries, Home and Foreign, who produce two goods Food and Clothing, using one factor of production, Labor. The unit input requirements are given by the table below in the two countries.
Good\Country
F ood
Clothing
Home
3
5
F oreign
9
3
Home has 60 units of labor while foreign has 90 units. Food is consumed in a one to one ratio relative to clothing at all prices by both countries. Use graph paper below. A sheet is attached.
a. (i) Draw the PPFs for each country and the world PPF under trade. What is the opportunity cost of a unit of food in terms of clothing at home and abroad?
(ii) If the price of clothing is 1, what is the price of food under autarky in each country and under free trade? In other words, what is the equilibrium relative price of food under autarky and free trade.
(iii) What are equilibrium wages (what a unit of labor earns) in each country under trade?
(iv) Who gains from trade and why? Does any country lose from trade?
b. Depict the trading equilibrium and the prices, production, imports and exports by each country in your graph. You do not need to solve for it algebraically, just to depict it on paper.
c. Suppose productivity at home doubled, that is, the unit labor requirements halved.
(i) What happens to world prices? Does the foreign country gain or lose from home becoming more productive? Does home gain from its productivity improvement?
(ii) In view of your answer to part (i) just above, comment on whether economically small countries are more ore less likely to gain from trade.
d. When Chinese productivity rises, their supply shifts out and the world prices for goods they export fall. This is good for the rest of the world though the Chinese may ?nd that they are gaining less than their productivity improvement would suggest due to adverse terms of trade e?ects”. Comment in view of your
answers to part c. above.
e. Depict the PPF for the world assuming labor is internationally mobile.
f. Can the PPF when labor is mobile between countries lie strictly outside the world PPF through trade or must it touch it somewhere? Can you give conditions under which they would touch at some point and when they would not? (Hint: consider what happens when one country has an absolute advantage
in both goods and when this is not the case.)
g. Given your answers to part f., how would you respond to the following quote:
“Given the lack of trade barriers today, there are orders of magnitude more gains to be had from permitting labor migration than trying to further liberalize trade.”
h. What do you think you learnt from studying the Ricardian model of trade?
2. Developia produces two goods, manufactures and food, using three factors of production: capital, land and labor. The production of manufactures requires capital and labor, while the production of food uses land and labor. All the arable land is in the south while all the factories are in the north. Labor is
mobile between regions and sectors. The economy faces a given world prices of cloth and food, and has given endowments of capital, land, and labor. Let the price of cloth be one.
a. Explain how to draw the PPF.
b. What is the e?ect on the allocation of labor between sectors and of output of the two goods in Developia of a freeze in the rest of the world that resulted in an increase in the world price of food.
c. How does this a?ect the production point along the PPF?
d. What is the e?ect of the freeze on the nominal and real earnings of each of the factors?
e. The freeze also results in migration into Developia. What is the e?ect of this migration on the post freeze equilibrium? In particular, what happens to the PPF, to the output and to the nominal and real earnings of the three factors?
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