Consider two countries, A and B, each with a labor force of 40 units (the unit c
ID: 1134140 • Letter: C
Question
Consider two countries, A and B, each with a labor force of 40 units (the unit could be ‘millions of hours’ or ‘millions of workers’ who work a fixed number of hours). Suppose that labor can be used to produce two types of goods, cloth (C) and food (F), which are sold in competitive markets. For the moment, we don’t consider other inputs (like capital, land, etc.), only labor; differences in productivity across countries and sectors are due to technology or other factors (like human capital and institutions) that we take as given.
Assume also that labor markets are perfectly competitive and labor can freely move across sectors (but not across countries).
The labor requirements (units of labor required to produce one unit of cloth or food) for each country are as follows:
(that is, in country A you need 4 units of labor to produce one unit of cloth, the same to produce one unit of food; in country B you need 2 units of labor to produce one unit of cloth, 1 unit of labor to produce one unit of food).
1) What is the productivity level (output per unit of labor) in each sector/country?
2) Which country has an absolute advantage in cloth? in food?
3) What is the opportunity cost of cloth in each country? What is the opportunity cost of food?
4) Which country has a comparative advantage in cloth? in food?
5) If there is no trade across countries (and there is a domestic demand for both goods), what would be the relative price of cloth in each country? [The relative price of cloth, PC/PF, is the ratio of the two monetary prices, or the value of one unit of cloth measured in units of food]
6) Now consider free trade across countries (forget transportation costs, let’s assume for simplicity that goods can be freely moved from one place to the other with no extra cost). The exact relative price that will prevail in the common international market depends of course also on the relative demand for each good; but supply conditions (as determined by productivity in each sector/country) limit the range in which the relative price will settle. What is that interval of possible equilibrium prices?
7) Suppose prices under free trade (expressed in the same currency, for example in euros) are the following: PC = 60, PF = 40 (PC is the price of cloth, PF the price of food). Which good will country A export? Which good will country B export? Will the two countries fully specialize? What will be the total output of each good?
8) Assume that each unit of labor receives a wage equal to the market value of the goods it produces. With the prices defined in the previous point, what will be the wage in country A? in country B? Compare them: what is the relative wage (which here is also the relative income) of country B (relative to A)?
Why is country B richer than country A? Does country A gains from trade? or would workers in A earn more (in real terms, that is in purchasing power) if they didn’t have to compete with country B’s exports? -----
C F A 4 4 B 2 1Explanation / Answer
1. Answer :- Prodductivity level for each sector and country :
Country A - Total no. of units/ per unit of labour = 40/4 = 10 units for cloths
Country B - Total no. of units/ per unit of labour = 40/2 = 20 units for cloths
Country A - Total no. of units/ per unit of labour = 40/4 = 10 units for food
Country B - Total no. of units/per unit of labour = 40/1 = 40 units for food
2. Answer :- Country B will get advantage in cloth and food.