CHAPTER 2

1. The gravity model is often used to not only explain between two countries, but
also to investigate the reason why they don’t. Illustrate this anomaly with suitable
examples and reasons.

The Gravity Model

 Countries tend to trade with close/ nearby economies
 Countries trade is proportional to their size (larger the trading partner
economy (GDP), the larger the volume of trade.

Why countries don’t trade

 Language and or culture barrier
 Bad neighbor of country
 Distance too long
 Borders
 Geography/ infrastructure
 tariff

2. Ireland and Belgium have very similar trading pattern. Both trade considerably
more with the United States than with European Union (EU), even though they
are EU members and are closer to the EU common market that the America
market. Explain this anomaly using gravity model.
3. Over the past few decades, East Asian economies have increased their share of
world GDP. Similarity, intra-East Asian trade - that is, trade among East Asian
nations - has grown as a share of world trade with each other. Explain why, using
the gravity model.

Before, there was little trade between the counties

- Their economies were small
Countries become more wealthy and able to import more
Became target for other countries export
Now, economic are larger, GDP high and they have small distance
o As to the gravity model, they trade more ( high GDP, close
distance)
CHAPTER 3
1. Home has 1,200 units of labor available. It can produce two goods, apple and
bananas. The unit labor requirement in apple production is 3, while in banana
production it is 2.
a. Graph Home’s production possibility frontier.
b. What is the opportunity cost of apples in term bananas?
c. In the absence of trade, what would be the price of apples in terms of
bananas? Why?
Answer 1 (a):
Formula of Production Possibility Frontier
= aLAQA + aLBQB < L
= (3 x unit of apple produce) + (2 x unit of bananas produce) < 1200
Home Unit Labor Requirement Labor
for Production Unit labor requirement

Apple (aLA = 3 Unit 1200/3=400

Bananas (aLB = 2 Unit 1200/4=600

Home’s Production Possibility Frontier. The line PF shows the maximum amount
of apple Home can produce given any production of bananas and vice versa.

Answer 1 (b):
When the production possibility frontier is a straight line, the opportunity cost of a
unit of apple in term of bananas is constant. As we saw Graph Home’s
Production Possibility Frontier in the answer 1 (a), this opportunity cost is defined
as the number of unit of bananas the economy would have to give up in order to
produce an extra unit of apple.
In this case, to produce another unit would require a LA person-hours. Each of
these person-hours could in turn have been used to produce 1/ a LB unit of
bananas.
Thus, the opportunity cost of apple in term of bananas is a LB/ aLA. It takes 3
person-hours to make a unit of apple and 2 person-hours to produce a unit of
bananas, the opportunity cost of each unit of apple is 1.5 unit of bananas.

Answer 1 (c):
In competitive economy, supply decisions are determined by the attempts of
individuals to maximize their earning. In simplified economy, since labor is the
only factor of production, the supply of apple and bananas will determined by the
movement of labor to whichever sector pay the higher wage.
We saw in the previous that it is the opportunity cost of apple in term of bananas.
aLA/ aLB = 1.50.
We have therefore just derived a crucial proposition about relationship between
price and production: the economy will specialize in the production of apple if the
relative price of apple exceed its opportunity cost in term of bananas. The price
of apple should be more than 1.5 times of price of bananas.

It will specialize in the production of bananas if the relative price of bananas is

less than its opportunity cost in terms of wine. The price of apple should be less
than 1.5 times of price of bananas.
2. Home is describe in problem 1. There is now also another country, Foreign, with
the labor force of 800. Foreign’s unit labor requirement in apple production is 5,
while in banana production it is 1.
a. Graph Foreign’s production possibility frontier.
b. Construct the world relative supply curve.
Answer 2 (a):
Formula of Production Possibility Frontier
= aLAQA + aLBQB < L
= (5 x unit of apple produce) + (1 x unit of bananas produce) < 800
Home Unit Labor Requirement Labor
for Production Unit labor requirement

Apple (aLA = 5 Unit 800/5=160

Bananas (aLB = 1 Unit 800/1=800

 Foreign’s Production Possibility Frontier. The line PF shows the maximum
amount of apple Home can produce given any production of bananas and
vice versa.
Answer 2 (b):
3. Suppose in an hour, 10 kg of rice and 5 meter of cloth is produced in India,
and 5 kg and 2 meter in Thailand. Using opportunity costs, explain which
country should export cloth and which should export rice.

A country is willing to produce more goods than other countries with the same
production factors and level of technology.

 Before specialization

Country Rice (Kg) Cloth (Meter)

India 10 5
Thailand 5 2

Based on the table above, using the same quantity of factors and the same level
of technology, India country is more efficient (has absolute benefits) in the
production of rice and cloth compared to Thailand country. In such a situation,
whether international trade can be conducted between the two countries depend
on the opportunity cost involved by both countries in producing rice and cloth.

Country Rice (Kg) Cloth (Meter) Opportunity Opportunity

cost in rice cost in
production cloth
production
India 10 5 5/10=0.50 10/5=2.0
Thailand 5 2 2/5=0.40 5/2=2.5

Based on the table above, India country has lower opportunity cost in rice
production compared to Thailand country. On the other hand, Thailand country
has lower opportunity cost in cloth production compared to India country.
Therefore, India country has comparative advantages compared in rice
production, while Thailand country has comparative advantage in cloth
production.

Comparative advantage

India: Rice
Thailand: Cloth

 During specialization,

Country Rice (Kg) Cloth (Meter)

India 0 10
Thailand 10 0
 India country should export cloth and Thailand country should export rice.

4. We have focused on the case of trade involving only two countries. Suppose that
there are many countries capable of producing two goods, and that each country
has only one factor of production, labor. What could we say about the pattern of
production and trade in this case? (Hint: try constructing the world relative supply
curve).

In the case of a market with multiple goods, the gains from trade would depend on the world
relative prices of the goods. The world relative supply curve here will be a step shaped curve
with multiple horizontal sections. These sections represent the unit labor requirements of the N
countries and the horizontal lines will be linked by multiple vertical lines. The downward sloping
demand curve will intersect the supply curve at a point that will represent the world relative
price. Companies to the left of this point can export the good (because they enjoy a comparative
advantage in it) to countries to the right of the curve. There is also a chance the intersection
occurs in the middle of one of these horizontal lines, which would mean that country specializes
in, and can produce, both goods.