Question

Home has 300 units of labor available. It can produce two goods, apples (QA) and bananas (QB). The unit labor requirement in apple production is 3, while it is 2 in banana production. There is now another country, Foreign, with a labor force of 800. Foreign’s unit labor requirement for apples is 8 and it is 2 for bananas.

a. Graph Foreign’s production possibilities frontier with the production of apples (QA*) on the x-axis. What is the opportunity cost of apples in terms of bananas in Foreign?

b. Which country has an absolute advantage in each good?

c. Which country has a comparative advantage in each good?

d. Draw the world relative supply curve for ratio of apples to bananas.

e. Now suppose world relative demand takes the following form: Demand for apples/demand for bananas = price of bananas/price of apples. Another way of writing it is: (QA+Q*A)/(QB+Q*B)=PB/PA. Graph the relative demand curve on the same graph as the relative supply curve.

f. What is the equilibrium world relative price of apples?
g. Using separate PPFs for each country, show how this world price increases the consumption possibilities and utility for each country.