1. Home has 1200 units of labor available. It can produce two goods, apples and bananas.
The unit labor requirement in apple production is 3, while in banana production it is 2.
a. Graph Home’s PPF.
Qbananas
600
1200/2=600
400
Qapples
1200/3=400
b. What is the opportunity cost of apples in terms of bananas?
3/2=1.5
The opportunity cost of apples in terms of bananas is 1.5 bananas per apple.
c. In the absence of trade, what would the price of apple in terms of banana be? Why?
PA/PB=1.5
In the absence of trade, the relative prices of goods equal their relative unit labor requirement.
The relative price equals the relative cost. In this case, we know that the wages are equal to the
cost, so in this case, we are saying that the prices will still be 3 apples per 2 bananas.
2. Home is a described in problem 1. There is now also another country, Foreign, with a
labor force of 800. Foreign’s unit labor requirement in apple production is 5, which in
banana production it is 1.
a. Graph foreign’s production possibility frontier
Qbananas
800
160
Construct the relative price of apple:
Qapples
We know the lowest relative prices at which apples are harvested is 3 apples per 2 bananas.
During this price, the relative supply curve is flat. With the maximum number of apples supplied
at 3/2, we know that home can provide 400 apples.At the same time, with the same price,
foreign can produce 800 bananas and no apples having a maximum relative supply at this price
of 1/2 . in this case we assume that the relative supply holds the prices between 5 and 3/2
Relative
price of
apples
(PA/PB)
5
5/1=5
3/2
3/2=3/2
\
½
400/800=1/2
Relative
quantity of apples
With the relative curve, we can conclude that if the price of the apples turned to 5. Both
countries would prefer to produce apples instead of bananas mainly because there is a
considerable gain.
3. Now suppose world relative demand takes the following form: Demand for
apples>demand for bananas = price of bananas>price of apples.
a. Graph the relative demand curve along with the relative supply curve.
Relative
price of
apples
Is 1 because we
assume the
foreign country
will produce
bananas
PA/PB
1
1/2
4
5
1/(PA/PB)
1
2
1/4
4
3/2
1
1/4
½
1
Relative
quantity of apples
b. What is the equilibrium relative price of apples?
The relative equilibrium price of apples is the intersection of the relative demand and the
relative curve. In this case, it is the point (1/2, 2). Thus, the equilibrium relative price is 2.
c. Describe the pattern of trade.
Home produces only apples, 400 in total, because they have a relative advantage compared to
the foreign country that can only produce 160. So, the foreign country produces only 800
bananas and trades with home to get the apples they need. Another point to consider is that
bananas are a bit cheaper in terms of labor for the foreign country, which is also why decides
only to produce bananas.
d. Show that both Home and Foreign gain from trade.
We know that without trading, Home could gain 3 bananas (6 unit labor) by forgoing 2 apples
(also 6 unit labor). In the case of foreign, he could gain 1 apple (5-unit labor) forgoing 5 bananas
(5-unit labor). The trades not only depend on the quantity but also the unit labor. Trading in
this situation allows each country to trade 2 bananas for 1 apple. For example, home trades 2
apples in exchange for 4 bananas (gaining one extra banana instead of harvesting it). That also
happens in the case of foreign; they can trade 2 bananas in exchange of 1 apple (gaining a
reduction of labor of 3). In this case, both countries gain either production or labor units.
4. Suppose that instead of 1,200 workers, Home has 2,400. Find the equilibrium relative
price. What can you say about the efficiency of world production and the division of the
gains from trade between Home and Foreign in this case?
In the case of incrementing the number of workers for home, a different amount of production
can affect the trading ecosystem between the foreign country.
With the new labor force, the home no longer needs to trade with the foreign country because
the opportunity cost of bananas in terms of apples for home is the same. So, homes do not gain
or lose from the trade.
Relative
price of
apples
(PA/PB)
PA/PB
1
1/2
4
5
4
1/(PA/PB)
1
2
1/4
2
3/2
1
Ç
1/4
1/2
1
800/800=1
Relative
quantity of apples
5. Suppose that Home has 2,400 workers, but they are only half as productive in both
industries as we have been assuming. Construct the world relative supply curve and
determine the equilibrium relative price. How do the gains from trade compare with
those in the case described in problem 4?
In this case, even if you double the number of employees, you are at the same level of 1,200
labor of production. There is no change at all. The only problem is that home is spending more
labor and not producing more final goods.
Relative
price of
apples
5
3/2
1/2
Relative
quantity of apples
6. Chinese workers earn only $0.50 an hour; if we allow China to export as much as it likes,
U.S. workers will be forced down to the same level. You can't import a $10 shirt without
importing the $.50 wage that goes with it. Is this right or wrong?
As I said previously, two countries will trade if there is a gain in production or labor. If the price
of product X is higher in a foreign country than the actual price in a country that wants the
product, the country would not want to buy that product from that specific foreign country.
We have to consider the comparative advantage between the countries because countries
want to specialize in a specific sector to trade between nations. In this case, China has a
substantial comparative advantage compared to other nations.
In this example, China and the US can benefit from one another. China sells as many goods as
possible, and the US gets clothing at a cheaper cost than any other nation producing t-shirts.
The US nation, in this case, will have a huge benefit because of the accessibility of cheap tshirts. However, this type of trading has consequences for US producers of t-shirts. Many of the
producers in the US will not be able to produce the same amount of t-shirts, and the wages of
production are going to be even higher in the US. In this scenario, the US producers will have to
either charge more for their t-shirts and makes their goods more luxurious or reduce the wages
to bring the prices of the goods to a competitive level with the Chinese companies or even
move to another country to produce their goods(offshoring).In the cases of bringing the goods
from China, the US will have to pay the 0.50 wage for the 10.00 dollar t-shirt because it is still
cheaper than the US t-shirts.
There is no easy solution when deciding whether to support your national companies or have
more goods at an affordable price. The act of patriotism will tell you to support your local
brands, but consumerism will ask you to get the most affordable products. Hence you will still
opt for Chinese products, which is not bad.
Suppose US brands decide to close their operations in the nation because of the wages and the
difficulty of competing with the Chinese brands or companies that produce in China. In that
case, there is going to be an increase in unemployment, but that situation is going to be for a
short time period. The US, in this case, needs to find sectors in which it can be more efficient
than any other nation and explode its resources to gain in those sectors.
To conclude is better exports t-shirt from China because they are cheaper even with the 0.50
wage imposed. The US needs to focus on other sectors that are more profitable and with better
outcomes in the long run.
7. Japanese labor productivity is roughly the same as that of the United States in the
manufacturing sector (higher in some industries, lower in others), while the United
States is still considerably more productive in the service sector. But most services are
non-traded. Some analysts have argued that this poses a problem for the United States,
because our comparative advantage lies in things that we cannot sell on world markets.
Explain what might be wrong with this argument.
The argument ignores the fact that comparative advantage in sectors depends on the service
productivity and each labor productivity of the whole economy, which needs to deal with labor
and wages. Not just in the production of services but also in the production of goods. So, in this
case, I would say that comparing the comparative advantage between Japan and the US based
on the service sector is a flawed interpretation of the comparative advantage the US has based
on labor productivity as a whole.
The competitive advantages of the industry, like in the case of service, depends on the relative
productivities of the industry and the relative wages across industries. So, to conclude which
country has a competitive advantage, the four aspects: the services sectors for both countries
and wages need to be considered. The prompt states that they only considered the services,
not the wages. Hence, it requires the addition of wages to conclude which one has a
comparative advantage.
8. Anyone who has visited Japan knows it is an incredibly expensive place; although
Japanese workers earn about the same as their U.S. counterparts, the purchasing power
of their incomes is about one-third less. Extend your discussion from question 7 to
explain this observation. (Hint: Think about wages and the implied prices of non- traded
goods.)
They have a higher standard of living. The production of luxurious goods and extravagant
services has helped into this problem. In this, we do not have to assume that the Japanese have
a terrible way of living because they even have a better medical system than the US. However,
they tend to produce these luxuries, services, and goods that also affect their financial
situation.
But on the contrary, they also have other services, like medicine at a cheaper cost, with
insurance asking for $15 to $40 US worth of value to get full access to the coverage. Like in this
case, we can assume that some goods and services are expensive, but there are also goods and
services provided at a low price. So, everything needs to be evaluated meticulously to perceive
whether the Japanese are in a better position than the Americans, that get paid more but pay
for goods and services, like insurance, at high prices.
Chapter 4
1. In 1986, the price of oil on world markets dropped sharply. Since the United States is an
oil-importing country, this was widely regarded as good for the U.S. economy. Yet in
Texas and Louisiana, 1986 was a year of economic decline. Why?
First of all, we need to consider Texas and Louisiana as the two highest producers of oil in the
United States of America.
Know what happened in 1986? Well, the price of oil dropped considerably, creating a massive
opportunity for the United States of America to import oil from other parts of the world at an
affordable price. Countries like the US can accomplish this theory because they want to protect
as many resources as possible on their land. So they would prefer to import oil from other parts
of the world that also are affected by the low market.
Texas and Louisiana are affected by this oil price reduction, but they cannot do anything to
reverse this problem because they cannot compete against the market. Besides, during that
period, thousands of people lost their job in domestic oil production because of the decline in
demand. For the United States, in general, it was Ok because they were importing oil at a low
price
2. An economy can produce good 1 using labor and capital and good 2 using labor and
land. The total supply of labor is 100 units. Given the supply of capital, the outputs of
the two goods depend on labor input as follows: The marginal product of labor curves
corresponding to the production functions (not given in the problem) are as follows:
Labor input to Good
1
0
Outside of Good 1
0.0
Labor input to Good
2
0
Output of Good 2
0
10
20
30
40
50
60
70
80
90
100
25.1
38.1
48.6
57.7
66.0
73.6
80.7
87.4
93.9
100
10
20
30
40
50
60
70
80
90
100
39.8
52.5
61.8
69.3
75.8
81.5
86.7
91.4
95.9
100
a) graph the production functions for good 1 and good 2
Production function for good 1
120
100
100
93,9
87,4
80,7
80
Output
73,6
66
60
57,7
48,6
40
38,1
25,1
20
0
0
0
20
40
60
Labor
80
100
120
Output of Good 2
120
100
91,4
86,7
81,5
80
Output
100
95,9
75,8
69,3
61,8
60
52,5
40
39,8
20
0
0
0
20
40
60
80
100
120
Labor
Graph the production possibility frontier? why is curved? PPF
Production Possibility Fontier
120
Output of good 2
100
100
95,9
91,4
80
86,7
81,5
75,8
69,3
61,8
60
52,5
40
39,8
20
0
0
0
20
40
60
Output of Good 1
80
100
120
The Production Possibility frontier shows that the curvature reflects a diminishing return to
labor in each sector. On the table, you can also appreciate that as more increases in delivery,
the workers have less capital to work with.
3. the marginal product of labor curves corresponding to the production functions in
problem 2 are as follows
Workers Employed
10
20
30
40
50
60
70
80
90
100
MPL in sector 1
15.1
11.4
10.0
8.7
7.8
7.4
6.9
6.6
6.3
6.0
MPL in sector 2
15.9
10.5
8.2
6.9
6.0
5.4
5.0
4.6
4.3
4.0
a) suppose that the price of good 2 relative to that of good 1 is 2. determine graphically
the wage rate and the allocation of labor between the two sectors
Formula for wage=
W=P*MPL
in this case:
GOOD 1:
W1= P1*MPL1
GOOD 2:
W2=P2*MPL2
in this case P2=P2/P1=2/1= 2 So, P1=1
Workers
Employed
10
20
MPL in sector 1
MPL in sector 2
15.1
11.4
15.9
10.5
Demand of
labor
P1*MPL1
15.1
11.4
Demand of
labor:
P2*MPL2
31.8
21
30
40
50
60
70
80
90
100
10.0
8.7
7.8
7.4
6.9
6.6
6.3
6.0
8.2
6.9
6.0
5.4
5.0
4.6
4.3
4.0
10.0
8.7
7.8
7.4
6.9
6.6
6.3
6.0
16.4
13.8
12
10.8
10
9.2
8.6
8
Labor demand in sector 1
16
15,1
14
12
11,4
MRPL
10
10
8,7
8
7,8
7,4
6,9
6
6,6
6,3
6
4
2
0
10
20
30
40
50
60
QUANTITY OF LABOR
70
80
90
100
Labor demand in sector 2
35
30
31,8
MRPL2
25
21
20
16,4
15
13,8
12
10
10,8
10
9,2
8,6
8
5
0
10
20
30
40
50
60
70
80
90
100
QUANTITY OF LABOR
35
30
WAGE
25
20
The wage rate in this
scenario is approximately
closed to 10.
15
10
5
0
10
20
30
40
MRPL1
50
60
70
80
90
100
MRPL2
MRPL1=MRPL2=1 happens when the labor demand in Good 1 is =30 and labor demand in good
2 is =70
So, the wage rate in this case is going to be= 10 or 1. and the value of marginal product in the
two sectors are going to be equal when labor in sector 1 is 30 and sector 2 is 70
b. using the graph drawn for problem 2, determine the output of each sector. then confirm
graphically that the slope of the production possibility frontier at that point equals the
relative price.
Production Possibility Fontier
120
Output of good 2
100
100
95,9
91,4
86,7
80
81,5
75,8
69,3
61,8
60
52,5
40
39,8
20
0
0
0
20
40
60
80
100
120
Output of Good 1
The labor demand in sector 1 is 30. the labor demand in sector 2 is 70., So the output produced
in sector 1 is 48.6. and the output produced in sector 2 is 86.7. the slope of the production
possibility curve is the relative price of good 1 with respect to good 2. thus, the slope is 1/2 .
C) suppose that the relative price of good 2 falls to 1.3 Repat (a) and (b)
Labor input to Good
1
0
10
20
30
40
50
60
70
80
90
100
Outside of Good 1
0.0
25.1
38.1
48.6
57.7
66.0
73.6
80.7
87.4
93.9
100
Labor input to Good
2
0
10
20
30
40
50
60
70
80
90
100
Output of Good 2
0
39.8
52.5
61.8
69.3
75.8
81.5
86.7
91.4
95.9
100
In this, we are assuming that the relative price of good 1 to good 2 is 1/1.3. and the price of
good 2 is 1.3 times of the price of good 1
Workers
Employed
10
20
30
40
50
60
70
80
90
MPL in sector 1
MPL in sector 2
15.1
11.4
10
8.7
7.8
7.4
6.9
6.6
6.3
15.9
10.5
8.2
6.9
6
5.4
5
4.6
4.3
Demand of
labor
P1*MPL1
15.1
11.4
10
8.7
7.8
7.4
6.9
6.6
6.3
Demand of
labor:
P2*MPL2
20.67
13.65
10.66
8.97
7.8
7.02
6.5
5.98
5.59
Labor demand in sector 1
16
15,1
14
12
11,4
MRPL
10
10
8,7
8
7,8
7,4
6,9
6
6,6
6,3
6
4
2
0
10
20
30
40
50
60
QUANTITY OF LABOR
70
80
90
100
Labor demand in sector 2
25
20,67
20
15
MRPL
13,65
10,66
10
8,97
7,8
7,02
6,5
5,98
5
5,59
5,2
0
0
20
40
60
80
100
120
Quantity of Labor
P1*MPL1
P2*MPL2
The wage rate in this
scenario is approximately
closed to 7.5
25
WAGE
20
15
10
5
0
10
20
30
40
50
60
70
80
90
100
MRPL1=MRPL2=7.8 happens when the labor demand in Good 1 is =57 approximately and labor
demand in good 2 is =43 approximately
So, the wage rate in this case is going to be= 7.5 or 0.75. and the value of marginal product in
the two goods are going to be equal when labor in good 1 is 60 and good 2 is 40.
Production Possibility Fontier
120
Output of good 2
100
100
95,9
91,4
80
86,7
81,5
75,8
69,3
61,8
60
52,5
40
39,8
20
1
0
0
0
20
40
60
80
100
120
Output of Good 1
We have assumed that labor demand in Good 1 is 60 and labor demand in good 2 is 40 to be
more accurate with the output values. So, the output produced in good 1 is 73.6 and the output
produced in good 2 is 69.3.
The production possibility curve is relative price of good 1 with respect of good 2. Thus, the
slope of the PPC at the point where the economy would produce is P1/P2 or 1/1.3.
c. calculate the effect of the price from change from 2 to 1.3 on the income of the specific
factor in sector 1 and 2.
1.3/2= 0.65-1=0.35%
-
P2/P1 falls from 2 to 1.3, meaning that the price of good 2 falls around 35%, and the
price of good 1 remains the same (1).
-
Because of the prices falling, wages fall as well. in the first scenario, we have wages
labor= 1, but then, when the price falls to 1.3, wages fall to 0.75, which is a 23%
reduction in wages.
-
Labor: the real wage of labor in the sector 2 has increased as the percentage in wage is
less than percentage fall in price of good 2. In this scenario,we are more tempted to
consume a bit more goods from the sector 2 . On the other hand, the real wage of labor
in sector 1 has fallen because there is no percentage change in price of good 1.There is
no effect of change in price in this case, but the reduction in sector 2 has affected the
consumption of sector 1.
-
Land: land is used in the good 2. The price of good 2 has diminished from 2 to 1.3.
-
capital: the relative price of good 1 has increased (1/1.3) so in this case we can conclude
that the production is better off compared of the relative price 1/2 .
4. Consider two countries (Home and Foreign) that produce goods 1 (with labor and
capital) and 2 (with labor and land) according to the production functions described in
problems 2 and 3. Initially, both countries have the same supply of labor (100 units
each), capital, and land. The capital stock in Home then grows. This change shifts out the
production curve for good 1 as a function of labor employed (described in problem 2)
marginal product of labor curve (described in problem 3). Nothing happens to the
production and marginal product curves for good 2.
a. Show how the increase in the supply of capital for Home affects its production
possibility frontier
With the information provided, the increase in capital for home affects the production
possibility of good 1. Because remember, capital is a variable of good 1. In this case, Good 2,
will not have a change because it depends on land. So, the graph will look like this:
GOOD 2
GOOD 1
b. On the same graph, draw the relative supply curve for both the Home and the Foreign
economy.
S
S1
GOOD 2
GOOD 1
C.If those two economies open up to trade, what will be the pattern of trade (i.e., which
country exports which good)?
if the economies open up to trade, Home will export good 1 and foreign country will export
good 2.
D. Describe how opening up to trade affects all three factors (labor, capital, land) in both
countries.
the result of opening up to trade, the three factors of production will increase, as production
will increase.
5. In Home and Foreign there are two factors each of production, land, and labor used to
produce only one good. The land supply in each country and the technology of
production are exactly the same. The marginal product of labor in each country depends
on employment as follows:
Number of Workers Employed
1
2
3
4
5
6
7
8
9
10
Marginal Product of Last Worker
20
19
18
17
16
15
14
13
12
11
11
10
Initially, there are 11 workers employed in Home, but only 3 workers in Foreign. Find the effect
of free movement of labor from Home to Foreign on employment,
production, real wages, and the income of landowners in each country.
MPL (Foreign)
MPL (Home)
LABOR
Giving those employment levels, real wages are higher in foreign (Point B) than at home point (
C). However, since we are considering the free labor movement between the two nations,
workers prefer to move from Home to Foreign. In this case, if there are 11 home workers and
only 3 foreign, it will increase the total production in the world as marginal production
increases in the emigration country until they both end in a similar real wage (Point A).
During the process of getting into Point A between home and foreign, the income of the
landlord owners will reduce because there will be people leaving the country, and the income
of landowners in the foreign countries will increase because there will be people immigrating.
6. Using the numerical example in problem 5, assume now that foreign limits immigration
so that only two workers can move there from home. calculate how the movement of
these two workers affects the income of five different groups:
a) workers who were originally in foreign: When only two workers are allowed to enter
the foreign country, the number of workers will go from 3 to 5. In the case of the
increment of workers, the marginal product of labor goes down from 18 to 16.
because workers are getting paid based on the marginal product of work, their
wages will be reduced as well.
b) foreign landowners: There is going to be an increase of workers from 3 to 5. Hence,
the foreign landowners will be better off from the original position. There are going
to be more people renting.
c) workers who stay in home: When two workers move to a foreign country. The labor
capability at home will go down from 11 to 9. The marginal productivity, in this case,
will have an increment from 10 to 12, Also having a wage increase. The workers at
home will be in a better position than when there were 11 workers.
d) home landowners: They will be worse off because the real rent will reduce because
of the two workers that moved to the foreign country.
e) the workers who do move: In this case, the two workers that moved to the foreign
country will be in a better position. The two will geta better real wage in the foreign
country because when they were at home their marginal product was 10 based on
11 workers, and now at the foreign country, their marginal product is 16 based on 5
workers. Hence, they will have a higher wage in the foreign country.
7. Studies of the effects of immigration into the United States from Mexico tend to find
that the big winners are the immigrants themselves. Explain this result in terms of the
example in the question above. How might things change if the border were open, with
no restrictions on immigration?
If there is no longer restriction on Immigration, immigrants will no longer become the big
winners. If the borders were open, thousands of people would like to migrate to the US
because of better work opportunities and ways of living. The problem of this free movement
between Mexico and the US will also have an enormous consequence on the wages because
workers will get paid less because of the operational inefficiency or lack of capital and land to
produce certain goods. The increase in population in the US will also be affected by the
unemployment rate; there will be thousands of people without the opportunity of getting a job.