Two countries, Home and Foreign, use only one factor, labor, to produce two goods, Shoes and...

 

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Two countries, Home and Foreign, use only one factor, labor, to produce two goods, Shoes and Computers. The Home country can produce a unit of Shoes with 2 units of labor and one Computer with 4 units of labor. The Foreign country can produce one unit of Shoes with 2 units of labor and a Computer with 2 units of labor. The Home country is endowed with a labor force of 200 units, while the Foreign country is endowed with a labor force of 100 units. Preferences are the same in the two countries and are described by the following Cobb-Douglas utility function: U(S,C) = sic HINT: an individual with these Cobb-Douglas preferences spends a share of her income on each product i.e. pcC= I and psS = I, where I is income 1. Imagine in particular that Home now becomes better at producing Shoes and its unit labor requirement for shoes goes from 2 to 1. (a) Draw the relative supply curve and find the new world equilibrium relative price of shoes to computers. What happens to consumption in Home (relative to before the technology improvement happened)? Comment on the effect of technological improvement in the Home country and explain the various channels through which technology has an effect on Home welfare (=consumption) (b) What is the effect of the technology shock on the Foreign country? Is the country better off or worse off? Why? Explain. Two countries, Home and Foreign, use only one factor, labor, to produce two goods, Shoes and Computers. The Home country can produce a unit of Shoes with 2 units of labor and one Computer with 4 units of labor. The Foreign country can produce one unit of Shoes with 2 units of labor and a Computer with 2 units of labor. The Home country is endowed with a labor force of 200 units, while the Foreign country is endowed with a labor force of 100 units. Preferences are the same in the two countries and are described by the following Cobb-Douglas utility function: U(S,C) = sic HINT: an individual with these Cobb-Douglas preferences spends a share of her income on each product i.e. pcC= I and psS = I, where I is income 1. Imagine in particular that Home now becomes better at producing Shoes and its unit labor requirement for shoes goes from 2 to 1. (a) Draw the relative supply curve and find the new world equilibrium relative price of shoes to computers. What happens to consumption in Home (relative to before the technology improvement happened)? Comment on the effect of technological improvement in the Home country and explain the various channels through which technology has an effect on Home welfare (=consumption) (b) What is the effect of the technology shock on the Foreign country? Is the country better off or worse off? Why? Explain.

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Explanation 1 A country has an absolute advantage over the other if it can produce the same good using fewer number of resources than the other countr... View the full answer