Chapter 2

1．Home has 1200 units of labor available. It can produce two goods,apples and bananas. The unit labor requirement in apple production is 3, whilein banana production it is 2.

a．Graph out the production possibilities frontier:

                  

  b．What is theopportunity cost of apples in terms of bananas?

c．In the absence of trade, what would the price of apples in terms ofbananas be?

     Inthe absence of trade, since labor is the only factor of production and supplydecisions are determined by the attempts of individuals to maximize theirearnings in a competitive economy, only when will both goods be produced. So

2．Home is as described in problem 1. There is now also anothercountry, Foreign, with a labor force of 800. Foreign’s unit labor requirementin apple production is 5, while in banana production it is 1.

  a．Graph Foreign’s production possibilities frontier:

   

b．Construct the world relative supply curve.

3．Now suppose world relative demand takes the following form: Demandfor apples/demand for bananas = price of bananas/price of apples.

  a．Graph the relative demand curve along with the relative supplycurve:

     

     ∵When the market achieves its equilibrium, we have

∴RD is a hyperbola

b．What is the equilibrium relative price of apples?

   The equilibrium relative price of apples isdetermined by the intersection of the RD and RS curves.

    RD:

    RS:

    ∴

    ∴

c．Describe the pattern of trade.

   ∵

   ∴In this two-country world, Home will specialize inthe apple production, export apples and import bananas. Foreign will specializein the banana production, export bananas and import apples.  

d．Show that both Home and Foreigngain from trade.

      Internationaltrade allows Home and Foreign to consume anywhere within the colored lines,which lie outside the countries’ production possibility frontiers. And theindirect method, specializing in producing only one production then trade withother country, is a more efficient method than direct production. In theabsence of trade, Home could gain three bananas by foregoing two apples, andForeign could gain by one foregoing five bananas. Trade allows each country totrade two bananas for one apple. Home could then gain four bananas by foregoingtwo apples while Foreign could gain one apple by foregoing only two bananas. Soboth Home and Foreign gain from trade.

4．Suppose that instead of 1200 workers, Home had 2400. Find theequilibrium relative price. What can you say about the efficiency of worldproduction and the division of the gains from trade between Home and Foreign inthis case?

RD:

    RS:

    ∴

    ∴

    In this case,Foreign will specialize in the banana production, export bananas and importapples. But Home will produce bananas and apples at the same time. And theopportunity cost of bananas in terms of apples for Home remains the same. SoHome neither gains nor loses but Foreign gains from trade.

5．Suppose that Home has 2400 workers, but they are only half asproduction in both industries as we have been assuming, Construct the worldrelative supply curve and determine the equilibrium relative price. How do thegains from trade compare with those in the case described in problem 4?

In this case, the labor is doubled while the productivity of labor ishalved, so the ＂effectivelabor＂remains thesame. So the answer is similar to that in 3. And both Home and Foreign can gainfrom trade. But Foreign gains lesser compare with that in the case 4.

6．”Korean workers earn only $2.50 an hour; if we allow Korea to exportas much as it likes to the United States, our workers will be forced down tothe same level. You can’t import a $5 shirt without importing the $2.50 wagethat goes with it.” Discuss.

   In fact, relative wage rate is determined bycomparative productivity and the relative demand for goods. Korea’s low wage reflects the fact that Korea is less productive than the United Statesin most industries. Actually, trade with a less productive, low wage countrycan raise the welfare and standard of living of countries with highproductivity, such as United  States. So this pauper labor argument iswrong.

7．Japanese labor productivity is roughly the same as that of the United States in the manufacturing sector(higher in some industries, lower in others), while the United States, is stillconsiderably more productive in the service sector. But most services arenon-traded. Some analysts have argued that this poses a problem for the United States,because our comparative advantage lies in things we cannot sell on worldmarkets. What is wrong with this argument?

   The competitive advantage of any industry dependson both the relative productivities of the industries and the relative wagesacross industries. So there are four aspects should be taken into accountbefore we reach conclusion: both the industries and service sectors of Japan and U.S., not just the two servicesectors. So this statement does not bade on the reasonable logic.

8．Anyone who has visited Japan knows it is an incredibly expensiveplace; although Japanese workers earn about the same as their U.S.counterparts, the purchasing power of their incomes is about one-third less.Extend your discussing from question 7 to explain this observation. (Hint:Think about wages and the implied prices of non-trade goods.)

   The relative higher purchasing power of U.S.is sustained and maintained by its considerably higher productivity in services.Because most of those services are non-traded, Japanese could not benefit fromthose lower service costs. And U.S.does not have to face a lower international price of services. So the purchasingpower of Japanese is just one-third of their U.S. counterparts.

9．How does the fact that many goods are non-traded affect the extentof possible gains from trade?

   Actually the gains from trade depended on the proportion ofnon-traded goods. The gains will increase as the proportion of non-traded goodsdecrease.