1. Home has 1,200 units of labor available. It can produce two goods, apples, andbananas.

The unit labor

requirement in apple production is 3, while in bananaproduction it is 2. (From the Textbook, Chapter 3,
Problem 1)a. Graph Home’s production possibility frontier.The production possibility curve is a straight
line that intercepts the apple axis at 400(1,200/3)and the banana axis at 600 (1,200/2).b. What is the
opportunity cost of apples in terms of bananas?The opportunity cost of apples in terms of bananas is
3/2. It takes 3 units of labor toharvest an apple but only 2 units of labor to harvest a banana. If one
forgoesharvesting an apple, this frees up 3 units of labor. These 3 units of labor could then beused to
harvest 1.5 bananas.c. In the absence of trade, what would be the price of apples in terms of bananas?
Why?Labor mobility ensures a common wage in each sector, and competition ensures theprice of goods
equals their cost of production. Thus, the relative price equals therelative costs, which equals the wage
times the unit labor requirement for applesdivided by the wage times the unit labor requirement for
bananas. Because wages areequal across sectors, the price ratio equals the ratio of the unit labor
requirement,which is 3 apples per 2 bananas.2. Home is as described in problem 1. There is now also
another country, Foreign,with a labor force of 800. Foreign’s unit labor requirement in apple
productionis 5, while in banana production it is 1. (From the Textbook, Chapter 3, Problem2)

a. Graph Foreign’s production possibility frontier.The production possibility curve is linear, with the
intercept on the apple axis equal to160 (800/5) and the intercept on the banana axis equal to 800
(800/1).

b. Construct the world relative supply curve.The world relative supply curve is constructed by
determining the supply of applesrelative to the supply of bananas at each relative price. The lowest
relative price atwhich apples are harvested is 3 apples per 2 bananas. The relative supply curve is flatat
this price. The maximum number of apples supplied at the price of 3/2 is 400supplied by Home while, at
this price, foreign harvests 800 bananas and no apples,giving a maximum relative supply at this price of
1/2. This relative supply holds forany price between 3/2 and 5. At the price of 5, both countries would
harvest apples.The relative supply curve is again flat at 5. Thus, the relative supply curve is stepshaped,
flat at the price 3/2 from the relative supply of 0 to 1/2, vertical at the relativequantity 1/2 rising from
3/2 to 5, and then flat again from 1/2 to infinity.3: Suppose world relative demand takes the following
form: Demand forapples/demand for bananas = price of bananas/price of apples. (From theTextbook,
Chap 3, Problem 3)a) Graph the relative demand curve along with the relative supply curve.The relative
demand curve includes the points (1/5, 5), (1/2, 2), (2/3, 3/2), (1, 1), (2,1/2).b) What is the equilibrium
relative price of apples?The equilibrium relative price of apples is found at the intersection of the
relativedemand and relative supply curves. This is the point (1/2, 2), where the relativedemand curve
intersects the vertical section of the relative supply curve. Thus, theequilibrium relative price is 2.

c) Who has a higher opportunity cost of making T-shirts?The opportunity cost of making T-shirts for
Mike is 10/3 = 3.33 hamburgers.Similarly, the opportunity cost of making T-shirts for Johnson is 7/4 =
1.75hamburgers. Hence, the opportunity cost of making T-shirts is higher for Mike.d) Who has a
comparative advantage in producing hamburgers?The opportunity cost of making a hamburger for mike
is 3/10 = 0.30 T-shirts.Similarly, the opportunity cost of making a hamburger for Johnson is 4/7 = 0.57T-
shirts. Since Mike sacrifices less T-shirts to make a hamburger, Mike has anabsolute advantage in the
production of hamburgers.5. Japanese labor productivity is roughly the same as that of the United
States inthe manufacturing sector (higher in some industries, lower in others), while theUnited States is
still considerably more productive in the service sector. But mostservices are nontraded. Some analysts
has argued that this poses a problem forthe United States, because our comparative advantage lies in
things we cannotsell on world markets. What is wrong with this argument? (From the 10thedition
Textbook, Chapter 3, Problem 7)The problem with this argument is that it does not use all the
information needed fordetermining comparative advantage in production: this calculation involves the
fourunit labor requirements (for both the industry and service sectors, not just the two forthe service
sector). It is not enough to compare only service’s unit labor requirements.If a LS <a*LS Home labor is
more efficient than Foreign labor in services. While thisdemonstrates that the United States has an
absolute advantage in services, this is neither anecessary nor a sufficient condition for determining
comparative advantage. For thisdetermination, the industry ratios are also required. The competitive
advantage ofany industry depends on both the relative productivities of the industries and therelative
wages across industries.6. In China, local governments are responsible for setting the minimum wages.In
the United States, a network of federal laws, state laws, and local lows set theminimum wages. How can
this be associated with productivity and transformedinto a comparative advantage? (From the Textbook,
Chapter 3, Problem 7)In the given situation, we don’t have enough information to determine
thecomparative advantage in production. It is not enough to compare the minimumwages to predict
how the labor’s productivity can be a comparative advantage. Chinamight have an absolute advantage
in this specific comparison since the task of settingminimum wages belongs to local governments and
they can be higher or lower, inaccordance with their interests in gains. However, for determining a
comparativeadvantage, the industry ratios are also required. The competitive advantage of anyindustry
depends on both the relative productivities of the industries and the relativewages across industries.7.
We have focused on the cases of trade involving only two countries. Supposethat there are many
countries capable of producing two goods, and that eachcountry has only one factor of production,
labor. What could we say about thepattern of production and trade in this case? (Hint: Try constructing
the worldrelative supply curve.) (From the Textbook, Chapter 3, Problem 10)The world relative supply
curve in this case consists of a step function, with as many“steps” (horizontal portions) as there are
countries with different unit laborrequirement ratios. Any countries to the left of the intersection of the
relative demand

and relative supply curves export the good in which they have a comparativeadvantage relative to any
country to the right of the intersection. If the intersectionoccurs in a horizontal portion, then the
country with that price ratio produces bothgoods.

1. Home has 1,200 units of labor available. It can produce two goods, apples, andbananas. The unit labor
requirement in apple production is 3, while in bananaproduction it is 2. (From the Textbook, Chapter 3,
Problem 1)a. Graph Home’s production possibility frontier.The production possibility curve is a straight
line that intercepts the apple axis at 400(1,200/3)and the banana axis at 600 (1,200/2).

b. What is the opportunity cost of apples in terms of bananas?The opportunity cost of apples in terms of
bananas is 3/2. It takes 3 units of labor toharvest an apple but only 2 units of labor to harvest a banana.
If one forgoesharvesting an apple, this frees up 3 units of labor. These 3 units of labor could then beused
to harvest 1.5 bananas.c. In the absence of trade, what would be the price of apples in terms of
bananas?Why?Labor mobility ensures a common wage in each sector, and competition ensures theprice
of goods equals their cost of production. Thus, the relative price equals therelative costs, which equals
the wage times the unit labor requirement for applesdivided by the wage times the unit labor
requirement for bananas. Because wages areequal across sectors, the price ratio equals the ratio of the
unit labor requirement,which is 3 apples per 2 bananas.2

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The Heckscher-Ohlin (H-O) theorem states that a country that is capital abundant
will export the capital-intensive good. Likewise, the country that is labor abundant
will export the labor-intensive good. Each country exports that good that it
produces relatively better than the other country. In this model, a country’s
advantage in production arises solely from its relative factor abundancy

Leontief Paradox:

The Heckscher-Ohlin theorem gave a generalisation that the capital-abundant

counties tend to export capital-intensive goods while labour- abundant countries
tend to export the labour- intensive goods. W.W. Leontief put this generalisation to
empirical test in 1953 and found the results that were contrary – to the
generalisation provided by the H-O theory.

Leontief made use of 1947 input-output tables related to the U.S. economy. 200
groups of industries were consolidated into 50 sectors, of which 38 traded their
products directly on the international market. He took only two factors of
production— labour and capital.

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The Stolper-Samuelson theorem demonstrates how changes in output prices affect

the prices of the factors when positive production and zero economic profit are
maintained in each industry. It is useful in analyzing the effects on factor income
either when countries move from autarky to free trade or when tariffs or other
government regulations are imposed within the context of a Heckscher-Ohlin (H-
O) model