1)Suppose that each worker in the home country can produce three cars or two televisions. Assume that Home has four workers.

a)Graph the production possibilities frontier for the home country. (1p)

b)What is the no-trade relative price of cars at Home? (1p)

The relative price is equal to the ratio of productivity P*c/P*tv= 2/3

Suppose that each worker in the foreign country can produce two cars or three televisions. Assume that Foreign also has four workers.

c)Graph the production possibilities frontier for the foreign country. (1p)

d)What is the no-trade relative price of cars in Foreign? (1p)

P*c/P*tv=3/2

e)In which good does Foreign have a comparative advantage and why? (2p)

Foreign has a comparative advantage in the production of televisions. Home has acomparative advantage in the production of cars. Because they have a lower opprtunity cost of pruducing these products.

f)Suppose that in the absence of trade, Home consumes nine cars and two televisions and Foreign consumes two cars and nine televisions. Add the indifference curve for each country to the figures in part (a) and (b). Label the production possibilities frontier (PPF), the indifference curve (U1), and the no-trade equilibrium consumption and production for each country. Label Home and Foreign's no-trade consumption points as A and A*, respectively. (2p)

Now suppose the world relative price of cars is P*C / P*TV = 1.

g)What good will each country specialize in? Briefly explain why ? (1p)

Home would specialize in cars, export cars, and import televisions. Foreign would specialize in televisions, export televisions, and import cars. Becase their pre-trade prices are less than world price of 1.

For home: P*c/P*tv= 2/3

For foreign:P*c/P*tv=3/2

h)Graph the new world price line for each country (in the same figure), and add a new indifference curve (U2) for each country in the trade equilibrium. (2p)

* Home consumes nine cars and two televisions (will export cars, import television)

* Foreign consumes two cars and nine televisions (will export television, import cars)

i)Label the exports and imports for each country. (2p)

Exports and imports for each country areshown in the graph above.

j)Does each country gain from trade? Briefly explain why or why not. (2p)

Yes, higher indifference curve implies higher welfare.