Determine the equilibrium relative price

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Reference no: EM133706623

Question: Assume that Home and Foreign produce only two goods - Oil and Corn. Home has 900 units of labour available. In Home, the unit labour requirement in Oil production is 6 and in Corn production it is 2. On the other hand, Foreign has 1800 units of labour available. Foreign's
unit labour requirement in Oil production is 18, while in Corn production it is 3.

a. Graph both Home's and Foreign's production possibility frontiers with the quantity of oil on the horizontal axis and the quantity of corn on the vertical axis.
b. Calculate the opportunity cost of producing Oil in terms of Corn in both Home and Foreign.
c. In the absence of trade, what would the price of Oil in terms of Corn be in both countries? Why?
d. Construct the world relative supply curve using the relative price and relative quantity of oil. Explain clearly the steps of deriving world relative supply curve in details. Illustrate it on a diagram. Now suppose world relative demand takes the following form:
Demand for Oil/demand for Corn = price of Corn/price of Oil.
e. Graph the world relative demand curve along with the world relative supply curve.
f. What is the free-trade equilibrium relative price of Oil?

g. Describe the pattern of specialization and trade.

h. Show that both Home and Foreign gain from trade.

i. Suppose that the number of workers decreases from 900 to 450 in Home. Find the new equilibrium relative price. What can you say about the efβiciency of world production and the gains from trade between Home and Foreign in this case?

j. Suppose that Home has now 450 workers, but they are twice as productive in both industries as we have been assuming. Consider Foreign to have the initial 1800 workers and the same productivity in both industries. 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 h.

Reference no: EM133706623

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