PROBLEM SET 1
due at the beginning of the lecture, in class on Wednesday, Jan. 13th
1. Consider a simplified world with two countries: Home and Foreign and two goods: snowboards
and bicycles. Both countries use labor as the only factor in production. Both countries are
endowed with 100 workers.
a. Suppose each worker in Home can produce either 4 snowboards or 2 bicycles a day. Please graph
the PPF for the Home country.
b. Suppose each worker in Foreign can produce either 3 snowboards or 3 bicycles a day. Please
graph the PPF for the Foreign country.
c. What is the no-trade relative price of snowboards for Home? for Foreign?
d. Which good(s) does Home have absolute advantage in? Which good(s) does Home have
comparative advantage in?
e. In no-trade equilibrium, Home consumes 200 snowboards and 100 bicycles while Foreign
consumes 100 snowboards and 200 bicycles. Please add the indifference curves to the graphs in
part a. and b. and label Home and Foreign’s no-trade consumption point as A and A*,
f. Do Home and Foreign have incentive to trade? If no, explain. If yes, please specifies who
g. If Home and Foreign agrees to trade, what is the range of the relative price of Psnowboard/Pbicycle?
h. (Difficult) Continue with the trade scenario. At the trade equilibrium, if Home consumes 100
snowboards and 200 bicycles, what is the equilibrium relative price of snowboad Psnowboard/Pbicycle?
i. How many snowboards and bicycles does Home export or import?
j. Continue with the trade scenario. How many snowboards and bicycles does Foreign export or
k. Label the exports and imports for each country. Does each country gain from trade? Briefly
explain why or why not. (Hint: Draw a new indifference curve in each country to show the
change in welfare.)
l. Draw the export supply and import demand curves for snowboard. Carefully mark the axes and
the coordinates of the kinked point and the intersection point.
2. Assuming that Home and Foreign produce both cars and TV in artarky.
a. Please fill out the following table:
Wagec= 30 Wagetv= ? Wage*
c= ? Wage*
MPLc= 3 MPLtv= ? MPL*
Pc= ? PTV= 4 P
c= 6 P
b. Which country has comparative advantage of producing cars? TVs?
c. Suppose the world relative price of cars in trade equilibrium Pc
/PTV=2, what is the real wage for
Home worker at trade equilibrium?
d. In trade equilibrium, what is the real wage for Foreign worker?
e. In the trade equilibrium, do Foreign workers earn more or less than those at Home, measured in
terms of their ability to purchase goods? Explain why.