Suppose the Home country has a fixed labour supply of 3600 hours and the Foreign country has 2400 hours of labour supply. Each country produces only two goods: bananas and coconuts. The unit labour requirement in bananas is 9 hours in Home and 15 in Foreign, while the unit labour requirement in coconuts is 6 hours in Home and 3 in Foreign.

a) Graph Home's production possibilities frontier on one graph (with coconuts on the x-axis) and Foreign's production possibilities frontier on another graph. Remember to label!

b) What is the opportunity cost of bananas in terms of coconuts for each country?

c) In autarky, what will be the price of bananas in terms of coconuts in each country? Why?

d) Using the above information graph the World relative supply curve, with the relative price of bananas on the y-axis and the relative quantity of bananas on the x-axis.

e) Now suppose World relative demand takes the following form: QB QC = PC PB . Determine the relative price of bananas in equilibrium.

f)What is the pattern of trade?

g) Do both countries gain from trade? Why?

h) Use the information from Problems 1-3 to determine the relative wage,( w/w*)

Part 2

Now suppose that there is a plague in the Home country, such that the home country's labour supply decreases to 1800 hours. (You may assume this influx does NOT come from the Foreign country, so that Foreign's labour supply is unchanged)

a) What is the new relative price of bananas in equilibrium?

b) What is the pattern of trade now?

part 3

Now suppose that after the plague, there is a technological innovation in the Foreign country, such that the unit labour requirement for bananas in Foreign decreases to 2 hours. At the same time, Home experiences an increase in its labour supply, from 1800 hours up to 7200 hours. (Note, this implies that the changes from Problem 6 occur after the changes from Problem 5 have already occurred.)

a) What is the new relative price of bananas in equilibrium?

b) What is the pattern of trade now?