1) There are two countries, East and West, and two goods, clothing (C) and food (F)

In the East, it takes 3 units of labour to produce a unit of Clothing and 3 units of labour to make a unit of Food. In the West, a unit of Clothing requires 8 units of labour, and unit of Food requires 2 units of labour. Assume that East has 600 units of labour, and West has 800 units of labour.

(a)What is the opportunity cost of Clothing in terms of Food in each country?

(b)Which country has an absolute advantage in which good?

(c)Which country has a comparative advantage in which good? Why?

(d)Draw the production possibilities frontier for each country (put Clothing on the

horizontal axis). Label axes and slopes.

(e)Draw the world production possibilities frontier (assuming labour does not move

between countries). Again, put Clothing on the horizontal axis. Label axes and

important points on the diagram.

(f)Draw the world relative supply curve (labelled RS) for C/F as a function of the relative

price of Clothing pC/pF (assuming labour does not move between countries). Label axes

and important points on the diagram.

(g)On your diagram in (f), draw a Relative Demand curve (labelled RD1) that yields an

equilibrium where each country is specialized in producing the good in which it has a comparative advantage. Which country exports which good? Do they both gain from trade? Why?

(h)Redraw the relative supply curve from (f) and now draw a Relative Demand curve (labelled RD2) that yields an equilibrium where West produces both goods and East is specialized in producing only one good. Which country exports which good? Do they both gain from trade? Why?

2) Suppose the world starts out the same as in 1(g) above. Suppose now that Food productivity rises in West so that it now takes 1 unit of labour to produce a unit of Food in West. Everything else stays the same.

(a)Show how this affects West's production possibilities frontier

(b)Draw the new world relative supply curve (on a diagram where you can compare it with the old relative supply curve).

(c)What happens to the world relative price of Clothing? Why?

(d)What happens to the terms of trade in each country? (Do they improve or worsen)?

(e)Are workers in East better off or worse off? Why? Show what happens to purchasing

power of an Eastern worker.

(f)Are workers in West better off or worse off? Why? Show what happens to purchasing

power of a Western worker.