One day, while walking along the beach, Robinson Crusoe saw a canoe in the water. In the canoe was a native of a nearby island. The native told Robinson that on his island there were 100 people and that they all lived on fish and coconuts. The native said that on his island, it takes 2 hours to catch a fish and 1 hour to find a coconut. The native said that there was a competitive economy on his island and that fish were the numeraire. The price of coconuts on the neighboring island must have been _________ The native offered to trade with Crusoe at these prices. “I will trade you either fish for coconuts or coconuts for fish at the exchange rate of __________ coconuts for a fish,” said he. “But you will have to give me 1 fish as payment for rowing over to your island.” Would Robinson gain by trading with him?
____________ If so, would he buy fish and sell coconuts or vice versa? ________________
(a) Several days later, Robinson saw another canoe in the water on the other side of his island. In this canoe was a native who came from a different island. The native reported that on his island, one could catch only 1 fish for every 4 hours of fishing and that it takes 1 hour to find a coconut. This island also had a competitive economy. The native offered to trade with Robinson at the same exchange rate that prevailed on his own island, but said that he would have to have 2 fish in return for rowing between the islands. If Robinson decides to trade with this island, he chooses to produce only __________ and will get his _________ from the other island. On the graph above, use black ink to draw Robinson’s production possibility frontier if he doesn’t trade and use blue ink to show the bundles he can afford if he chooses to trade and specializes appropriately. Remember to take away 2 fish to pay the trader.
(b) Write an equation for Crusoe’s “budget line” if he specializes appropriately and trades with the second trader. If he does this, what bundle will he choose to consume? __________ Does he like this bundle better than the bundle he would have if he didn’t trade? _________