Mikkel Krakau Holm International Economics 7/10-2022

Problem set 3
1)
a.
Opportunity costs:
Home country:
pA 1
p A =1 , p B=2 , p H = =
pB 2
Can be stated as:
1
1 A= B ⇔1 B=2 A
2
Where A=Apples and B=bananas
These are the opportunity costs of Apples and Bananas
For Foreign Country:
F pA 6
p A =6 , p B =3 , p = = =2
pB 3
1
1 A=2 B⇔ 1 B= A
2
So due to the lower opportunity costs, we see that home country has a comparative advantage in
apples and foreign country has a comparative advantage in bananas.

b.
We assume that the countries are in an autarky state, so they cannot trade. Because we assume
that workers can freely move from one industry to another, we must assume w A=w B.
Furthermore, we assume that we want to consume both products in both countries. These
p A pB
assumptions imply = ⇔ w A =w B. If we move around we can get the relative price for
a LA a LB
apples:
p A a LA
p A a LB = pB a LA ⇔ =
pB a LB
And for bananas:
pB a L B
=
p A aL A
This will give autarky prices that equals the opportunity costs for both products in both countries.
So, relative prices are as follows:
H pA 1
p = =
pB 2
p 6
p F= A = =2
pB 3
c.
World relative supply:
First step

World relative supply of apples will equal the Home country’s max apple production divided by the
Foreign country’s max banana production. The maximum production is given by the full labor force
Mikkel Krakau Holm International Economics 7/10-2022

divided by the unit labor requirement. We know that the countries have the same population and
therefore we assume same labor force as well, L=L¿. Therefore we get the following expression
for world relative supply of apples:

( )
SA= ¿ =
L
a LA a¿LB
=3
( )
L aLA
¿
a LB
World relative supply of bananas:

( )
L
aL B
S B= ¿ =
a¿LA 6
= =3
( )
L a LB 2
a¿L A

d.
There will be 2-way trade when the relative price is in between the two opportunity costs:
a LA ' p A a¿LA
≤p= ≤ ¿ ⇔
a LB p B a LB
1 '
≤ p ≤2
2
So there will be trade when the relative price is bigger than ½ and less than 2.

e.
?

f.
So in a no trade situation if we assume that both countries have a labor force of 100 units and they
split the labor force evenly, the two countries will have a production as follows:
Home:
50
Apples= =50
1
50
Bananas= =25
2
Foreign:
50
Apples= =8,33
6
50
Bananas= =16,66
3
So in a no trade situation the production above is also their consumption. Total consumption =
50+25+ 8,33+ 16,66=100

In a trade situation where home country specializes in apples and foreign country in bananas we
have the following production:
100
Apples= =100
1
Mikkel Krakau Holm International Economics 7/10-2022

100
Bananas= =33,33
3
Total consumption = 100+33,33=133,33
So there is gain of trade. This could also be shown graphical, where trading would allow both
countries to reach a higher PPF and therefore higher utility.

2)
The size of the population will affect the size of the labor force which will affect the relative supply.

( )
SA= ¿ =
L
a LA L aLB
·
¿

( )
L aLA L¿
¿
a LB
As L¿ will increase the relative supply will decrease. This will mean that foreign country can
produce more of each good, and the price of the good that they specialize in (banana) will
decrease and the price of apples will increase.

3)
Just as in the case with only two goods, the countries will specialize in and only produce the goods
in which they have a comparative advantage.