Consider two countries, Green (Home) and Purple (Foreign), which produce butter and jam. There is only one factor of production (labor). In order to produce a pound of butter, a Home worker needs 5 hours, while a Foreign worker needs 4 hours. In order to produce a pound of jam, a Home worker needs 4 hours, while a Foreign worker needs 3 hours. Markets are perfectly competitive. Labor endowments are equal across countries:

L = L* = 3300 hours

a) What are the unit labor requirements for each product (butter and jam) in each country? What is the opportunity cost of a pound of butter in terms of pounds of jam in Home? And in Foreign?

b) What country has a comparative advantage in which good and why?

c) Draw the production possibility frontiers for Home and Foreign, in two separate graphs. In each, place butter on the horizontal axis and jam on the vertical axis.

d) Draw the world relative supply, with the relative price of butter in terms of jam on the vertical axis, and the relative quantity of butter on the horizontal axis

e) Draw the world relative demand curve that crosses the relative supply curve at a point such that the relative price of butter is 1.29 pounds of jam. What good (or goods) will Home produce at this price? What good (or goods) will Foreign produce at this price?

f) In two new, separate graphs draw the consumption possibility frontiers for Home and Foreign when the relative price of butter in terms of jam is 1.29. Are there gains from trade for Home? Why or why not? And for Foreign? Why or why not?

g) Now assume that the relative demand shifts and crosses the world relative supply at a relative price equal to 1.25 pounds of jam for a pound of butter. Draw the new consumption possibility frontiers for Home and Foreign in two separate graphs. At this different relative price, are there gains from trade for Home? And for Foreign? Why or why not?