1- Suppose that a small open economy has 200 workers and that its technology req
ID: 1104068 • Letter: 1
Question
1-
Suppose that a small open economy has 200 workers and that its technology requires 1 worker-hour per unit of food (thus 1 unit of food per worker-hour) and 3 worker hours per unit of cloth (thus output per worker-hour = 1/3). In autarky, it employs 100 workers in each of the two industries. With free trade, it faces world prices of $10 per unit of food and $20 per unit of cloth.
a.Suppose that in autarky, workers in both industries are paid $8 per hour. What are the autarky prices of food and cloth?
b.When the country opens to free trade, under the normal assumptions of the Ricardian model, what will it produce, import, and export? From the information given, can you determine the quantities of any of these? What is the country’s national income with trade, measured in dollars?
c.Suppose, contrary to the normal Ricardian Model assumptions, that when trade is opened, workers are unwilling or unable to change occupations, so that we continue to have 100 workers in each industry. What, then, is the national income of the country, in dollars, and how does it compare to the national income you got in part (b) when workers were mobile?What are the wages of the two groups of workers in part (c)?
d.Does the country gain from trade in part (c)? Who gains and who loses within it?
Explanation / Answer
a. Autarky prices of food and cloth= cost per unit production
Cloth= 3*8 = $24 per 1 unit of cloth
Food = 1*8 = $8 per 1 unit of food
b. Under free trade price of 1 unit of food = $10
price of 1 unit of cloth = $20
Autarky relative price of food = aLF/aLC= 8/24 = 1/3
Price of food in world market = pF/pC = 10/20 = 1/2
Comparative advantage of food over cloth is greater as aLF/aLC is less than pF/pC, producing 1 unit of food is less than the world price in free trade, it will specialize in food production.
It will produce only food with 200 units per hour, will export food and imports cloth. National income onTotal production = 200*10 = $2000
Demand equation in required to estimate the quantity exported and imported.
c. if workers doesnt change the occupation
100 workers produce food= 100*1 = 100 units of food per hour
100 workers produce cloth = 100*(1/3 )= 33.3 units of cloth per hour
National income at world price
for food= 100*10 =1000, for cloth = 33.3*20 = 666, total = $1666.
national income reduced by $2000-$1666 when workers are not mobile. = $334.
Wages paid to workers in food industry, unit price per unit quantity = 10/1 = $10
Wages paid to workers in cloth industry = 20/3 = $6.67
d. The wages have increased for workers producing food and as well the price of food has increased to that extent. If the workers consume cloth, their pay offs are better.Similarly the wages have decreased for workers producing cloth and as well the price of cloth has decreased, their payoffs are worse if they consume food.
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