Consider a country called Italy, which can produce two goods, apples and bananas (A and B)....

   

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Consider a country called Italy, which can produce two goods, apples and bananas (A and B). Italy has L1200 units of labour available, and it takes it 3 units of labour to produce an apple, and 2 units of labour to produce a banana. 1. Draw the Italian production possibility frontier. 2. What is the opportunity cost of apples in terms of bananas? 3. In the absence of trade, what would the price of apples in terms of bananas be, and why? Now, assume that Italy can trade with another country called France. Denote French variables with a star. France has L* = 800 units of labour available, and takes 5 units of labour to produce an apple, and 1 unit of labour to produce a banana. 4. Draw the French production possibility frontier. 5. Draw the world relative supply curve. Assume from now on that in both countries, consumers have Cobb-Douglas preferences with equal spending shares on both goods (such as the ones used in Problem Set 1, or in the Lecture Slides). Then, we know that in Italy, 1 PA CA PB CB= (1200), and in France, 1 PA CA PB CB = · (800w*). 2 6. Show that these demand functions imply that the world relative demand is given by the following function: PA PB QB QA Hint: Use the fact that markets must clear, so that QA = CA + C and QB = CB + CB. If you cannot show this, take the result as given as proceed to the next questions. 7. Draw the relative demand curve in the same graph as the relative supply curve. Are the two countries in a situation of perfect specialization? 8. What is the equilibrium relative price of apples? 9. How many apples and bananas do Italians produce in the trade equilibrium? 10. How many apples and bananas do Italians consume in the trade equilibrium? Therefore, how many apples and how many bananas do Italians export or import? 11. Show that Italy gains from trade. Is this also true for France? Consider a country called Italy, which can produce two goods, apples and bananas (A and B). Italy has L1200 units of labour available, and it takes it 3 units of labour to produce an apple, and 2 units of labour to produce a banana. 1. Draw the Italian production possibility frontier. 2. What is the opportunity cost of apples in terms of bananas? 3. In the absence of trade, what would the price of apples in terms of bananas be, and why? Now, assume that Italy can trade with another country called France. Denote French variables with a star. France has L* = 800 units of labour available, and takes 5 units of labour to produce an apple, and 1 unit of labour to produce a banana. 4. Draw the French production possibility frontier. 5. Draw the world relative supply curve. Assume from now on that in both countries, consumers have Cobb-Douglas preferences with equal spending shares on both goods (such as the ones used in Problem Set 1, or in the Lecture Slides). Then, we know that in Italy, 1 PA CA PB CB= (1200), and in France, 1 PA CA PB CB = · (800w*). 2 6. Show that these demand functions imply that the world relative demand is given by the following function: PA PB QB QA Hint: Use the fact that markets must clear, so that QA = CA + C and QB = CB + CB. If you cannot show this, take the result as given as proceed to the next questions. 7. Draw the relative demand curve in the same graph as the relative supply curve. Are the two countries in a situation of perfect specialization? 8. What is the equilibrium relative price of apples? 9. How many apples and bananas do Italians produce in the trade equilibrium? 10. How many apples and bananas do Italians consume in the trade equilibrium? Therefore, how many apples and how many bananas do Italians export or import? 11. Show that Italy gains from trade. Is this also true for France?

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1 Italian Production Possibility Frontier PPF Italy has 1200 units of labor Apples take 3 units of labor per unit Bananas take 2 units of labor per unit Imagine a graph with apples on the Xaxis and ba... View the full answer