Question

Consider a world with two countries, Home and Foreign, both able to produce two goods: cloth and tablet computers. The p...

Consider a world with two countries, Home and Foreign, both able to produce two goods: cloth and tablet computers. The production of both goods uses
capital and labor in fixed proportions, with the tablets industry using more capital per worker than the cloth industry. The units of each input needed to produce one unit output are given by:

capital Labor
Cloth 1 2
Tablets 2 1


Both countries have 150 units of capital available for production, but the Home country has 100 units of
labor whereas the Foreign country has 200. Consumers like to consume both goods and have the same
preferences in both countries. Assume that the countries are closed to international trade.


a) Construct the PPF for both countries and put them in the same graph. Show in the graph the quantity
of both cloth and tablets that are produced by each country in equilibrium, if the countries are not
trading. [HINT: assume regular indifference curves and use the graph to determine the quantity of
each good demanded at the highest indifference curve.] Compute these quantities algebraically.

b) Which country produces more cloth relative to tablets? Indicate how this feature relates to the
country’s relative factor endowments.

c) Compute the quantities of labor and capital employed in each country in the production of each of
the goods at the output levels in a).

d) Indicate the range of prices of cloth relative to tablets at which the Home country will produce both
goods. Which good would be produced if the relative price was outside of this range?

e) In which country will the price of cloth relative to tablets be higher? Explain.

f) Assume that both countries open to trade with each other. Explain how the price of cloth relative to
trade will change in each country after opening to trade.

g) According to the Heckscher-Ohlin theorem, if these two countries opened to trade, which country
would export which good? Explain.

h) Give intuition about who will be better off and who will be worse off in each country after opening
to trade. Explain.

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Answer #1

Based on the given information

The production possibility of both countries are as follows

Capital Home 150 Labor 100 Left Cap Capital C Labor C Cloths Left Lab Labor T Tablet Total Cap Total Lab Total Production Cap

Away Capital 150 Labor 200 Capital C Labor C Left Cap Cloths Left Lab Labor T Tablet Total Cap Total Lab Total Production Cap

The production possibility frontier can be created using following information

For Home Country

Tablet Cloths 75 70 66 60 0 10 17 20 30 40 20 40 50 R

For Away Country

Cloths Tablet 75 70 10 65 20 60 30 55 40 50 50 45 60 40 70 80 35 82 34 84 32 20 90 100

a)

PPF 80 70 60 50 40 Away 30 Home 20 10 0 20 40 60 80 100 120 Cloths Tablet

b)

As given in the question that the consumer like to consider both the goods in both countries. So both the goods has equal demand of equal WTP. In this case the country will benefit by producing a combination which will result in a higher highest total output. i.e. sum of both products should be maximum

In the case from the table above we can see that the maximum production by home country is 8 which is produced by combination of 17 cloths and 66 tablets. Thus, home country will produce more tablets than cloths.

The maximum production by away country is 116 which is produced by combination of 82 cloths and 34 tablets or 84 cloths and 32 tablets. Thus, home country will produce more cloths than tablets.

c) From table we can see that both countries use total capital and labor assigned to them

i.e. for home country

Capital = 150 and Labor =100

For away country

Capital = 150 and Labor =200

d) We considered both are equally important and thus price of both of them must be equal. Assuming tablets has a price of 1 unit. And price of Cloth is x unit

Then the country will produce only cloths if

50x > 17x + 66

x > 2

and will produce only tablets if

75 > 17x + 66

x < 0.53

Hence, the price of cloth should be more than 53% of price of tablet and less than 200% of price of cloth

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