HW # 4: PROBLEM SET

Comparative Advantage, Gains from Trade, and the Ricardian Model

Consider two countries, the United States and India, producing two commodities, food, and clothing. The United States needs one and a half hours of labor to produce a unit of food and one hour to produce a unit of clothing. India needs three hours of labor to produce a unit of food and one hour to produce a unit of clothing. The United States is endowed with 800 hours of labor while India is endowed with 1000 hours of labor.

1. Draw a table to show the unit labor requirements for each country for each commodity. Which country has an absolute advantage in the production of food? In the production of clothing?Why?Which country has a comparative advantage in the production of food?In the production of clothing?Why?

2. Draw the production possibility frontiers (PPF) for each country, placing clothing on the horizontal axis and food on the vertical axis.What is the marginal rate of transformation (MRT) (the slope of the PPF) in each country?Which country will export which good?

We now assume that the representative individuals in the two countries have preferences represented by the utility functions:

\fF I Fus and MRS MRSUs CusF IIC C LFIGURE 3-3 World Relative Supply Relative price and Demand of cheese, P/Pw The RD and RD' curves show that the demand for cheese relative to wine is a decreasing function of the alc/alw RS price of cheese relative to (2 in our that of wine, while the RS example) curve shows that the supply of cheese relative to wine is an increasing function of the same relative price. 2 RD alc/aww (1/2 in our example) RD' a LaLe Relative quantity of cheese, +Ow