Assume a two-country trading world that consists of Columbia and Ecuador, both of which produce coffee and oil. Suppose labour is the only factor of production, and the relative cost of producing one product in terms of another product is constant in both nations. The available supply of labour in Columbia and Ecuador is 2,400 and 1,600, respectively. The following table shows the unit labour requirements in coffee production and oil production in both countries.
a) Draw the production possibility frontier for each of these countries.
b) Calculate their autarky relative prices of Oil for each country.
c) Which country has an absolute advantage in Oil? Which in Coffee? Which has a comparative advantage in Oil? Which in Coffee?
d) What are the autarky wages of workers in Ecuador, in units of Oil per unit of labour? In units of Coffee per unit of labour? What are the autarky wages of workers in Columbia, also in units of Oil and in units of Coffee? Can you tell which country's workers are better off in autarky?
e) Assuming free trade, in what commodity should each nation specialise?
f) What is each country's gains from trading at a price ratio, POil/PCoffee = 1.0.