comparative advantage

1. Assume two goods, wheat and cloth, are produced using only labor (the Ricardian model) in two countries, called “Home” and “Foreign.” The chart below shows the total units of each good (i.e. production possibilities) that each country can produce using all of the available labor.

	Home	Foreign
Wheat	100 bushels	100 bushels
Cloth	50 yards	100 yards

a. Who has the absolute advantage in wheat? Explain why.

b. Who has the absolute advantage in cloth? Explain why.

c. In the space below, draw the production possibilities frontier for each country in autarky. Label the x-axis with wheat and the y-axis with cloth.

d. What is the opportunity cost of wheat in home?

e. What is the opportunity cost of cloth in home?

f. What is the opportunity cost of wheat in foreign?

g. What is the opportunity cost of cloth in foreign?

h. Who has the comparative advantage in wheat production? Explain why.

i. Who has the comparative advantage in cloth production? Explain why.

2. What good should each country import / export? Why?

3. How are relative price and opportunity cost related?

4. Now suppose trade is opened up between home and foreign. The relative price of wheat on the world market is 2/3 units of cloth.

a. What is the relative price of cloth on the world market?

b. Draw the new PPF / Consumption Possibilities for Home and Foreign with trade (on one graph). Label the x-axis with wheat and the y-axis with cloth.

c. Describe how we can measure gains from trade using points along the consumption possibilities frontier.