Home has 3,600 units of labor available. It can produce two goods, shirts and pants. The unit labor requirement in shirt production is 4, while in pants production it is 6. There is another country, Foreign, with a labor force of 2,400. Foreign’s unit labor requirement in shirt production is 2, while in pants production it is 10.
Graph Home’s production possibility frontier.
What is the opportunity cost of pants in terms of shirts for the home country?
In the absence of trade, what would be the price of pants in terms of shirts for the home country? Why?
Graph Foreign’s production possibility frontier.
What is the opportunity cost of pants in terms of shirts for the foreign country?
In the absence of trade, what would be the price of pants in terms of shirts the foreign country? Why?
Construct the world relative supply curve.
Now suppose world relative demand takes the following form: Demand for pants/demand for shirts = price of shirts/price of pants.
i. Graph the relative demand curve along with the relative supply curve.
ii. What is the equilibrium relative price of pants?
iii. Describe the pattern of trade.
iv. Show that both Home and Foreign gain from trade.
v. Suppose that the price of a pair of pants is $25. What is the relative wage in the home country (ratio of wages)?
vi. What are the relative productivities for the home country?
vii. Interpret your results in (v) and (vi)