ECO 360 International Economic Relations

Question 1 (11 points)
(1) Suppose Home has 2,000 units of labor available. It can produce two goods, clothing (C) and wheat (W). The unit labor requirement in clothing production is 5, while in wheat production it is 2.
(1 point) a. Let QC and QF be the quantities of clothing and wheat produced, derive Home’s production possibility frontier (PPF) and graph it.
(1 point) b. What is the opportunity cost of clothing in terms of wheat?
(1 point) c. What and how much does Home produce when the relative price of clothing is 3, i.e., pC/pF = 3?
(1 point) d. Which workers (clothing workers or wheat workers) earn higher wages when the relative price of clothing is 2.5, i.e., pC/pF = 2.5?
(2) Home is as described above. Now suppose there is another country, Foreign, with a labor force of 3,000. Foreign’s unit labor requirement in clothing production is 2, while in wheat production it is 4.
(1 point) a. Which country has an absolute advantage over the other in clothing production? Which has a comparative advantage over the other in wheat production?
(2 points) b. What and how much do Home and Foreign produce, respectively, when the world relative price of clothing is 0.5, i.e., pC/pF = 0.5.
(1 point) c. What is the range for the relative price of clothing under free trade?
(1 point) d. Suppose the world relative price of clothing under free trade is 2, i.e., pC/pF = 2. Describe the pattern of trade between Home and Foreign.
(2 points) e. Show that both Home and Foreign gain from trade at pC/pF = 2.

ECO 360 International Economic Relations

Question 3 (13 points)
(1) Consider Home produces computers(C) and food(F) using capital(C) and labor(L). The unit factor requirements are fixed and given by: aLC = 2, aKC = 6, aLF = 3, aKF = 4. The total labor supply is 900 and the total capital stock is 1,500.
(1 point) a. Which good is relatively labor intensive? Which good is relatively capital intensive?

(2 points) b. Derive and draw the PPF of this country. At which point on the PPF are both factors fully employed?
(2 points) c. Suppose Home produces at the point you find in b. According to Rybczynski theorem, what happens to the output mix if the total labor supply increases.
(1 point) d. Suppose autarky prices are given by PC = 10, PF = 10. At which point on the PPF does Home produce?
(2) Now suppose there is another country, Foreign, with a labor supply of 1,200 and a capital stock of 1,800. Foreign shares the same technology with Home (i.e., a
∗LC = 2, a ∗KC = 6,

a∗LF = 3, a∗
KF = 4). Home and Foreign engage in free trade. Suppose the world relative price of computers is given by PC/PF = 1.2.
(1 point) a. Which country is relatively capital abundant and which labor abundant?
(1 point) b. Describe the pattern of trade between Home and Foreign.
(2 points) c. Show graphically the production and consumption of Home under free trade.
(2 points) d. Who will gain and who will lose from free trade?
(1 point) e. In which country are wages higher?