Reference no: EM132813419
Assume that there are only two countries, the kingdoms of Florin and Guilder, each producing only two goods, really big blocks of cheese (X) and wagonloads of grain (Y) with the single input of labor under constant costs and perfect competition. Florin, the home country, has 3 million identical workers, each of whom can produce either 2 blocks of X or 6 wagonloads of Y per year. Guilder has 9.6 million workers, each of whom can produce either 1 block of X or 4 loads of Y per year.
-Putting X on the horizontal axis, draw and label the PPFs for both Florin and Guilder. Using indifference curves, show the consumption points (A and A*) assuming that each country devotes a third of its labor force to dairy production and two-thirds to wheat farming. Actual numbers (in millions) are required.
-Write the PPF equation for each country.
-Which has the absolute advantage in Y? Which has the comparative advantage in Y?
-Under free trade, which country would export which good, and why? This is called the Ricardian Theorem, by the way.
-Suppose both countries fully specialize. Show that moving to free trade from the previous points (A and A*) could lead to more total production of both X and Y.
-For each country, assuming that the price of Y relative to the price of X equals to 0.3, show the new Consumption Possibilities Frontier relative to the Production Possibilities Frontier.