Consider two countries, Home and Foreign, which are closed to international trade. Home has 1200 units of labour available, and Foreign has 800 units. Both countries can produce two goods, apples and bananas. Home's unit labour requirement in apple production is 3, while in banana production is 2. Foreign's unit labour requirement in apple production is 5, while in banana production it is 1.

a) Graph Home and Foreign's production possibility frontiers. [Plot apples in the x-axis.]

b) Define opportunity cost. Compute Home and Foreign's opportunity cost of apples in terms of bananas.

c) In the absence of trade, compute the price of apples in terms of bananas at Home and Foreign, assuming that consumers in each country like to consume both goods. Explain.

Assume now that the two countries open to trade with each other.

d)Define comparative advantage. Which country has comparative advantage in apples? And in bananas? Explain.

e) Construct the world relative supply curve. Show it in a graph.

f) Assume that the world relative demand takes the following form: (Demand for apples)/(Demand for bananas) = (Price of bananas)/(Price of apples), that is, (D_A / D_B)= 1 / (P_A /P_B). Plot the relative demand curve in the graph in e). Compute the equilibrium relative price of apples.

g) Describe the pattern of trade (who exports what?). Explain.