Consider two countries called Ricardia (Home) and Marxia (Foreign). They can produce two goods, Apples and Bananas, using a single factor of production, Labour, under con- stant returns to scale. Goods are freely traded internationally, but factors are immobile across countries.
In Ricardia, 4 labour hours are required to produce each unit of apples, and 3 labour hours are required to produce each unit of bananas. In Marxia, 1 labour hour is required for each unit of apples and 2 labour hours are required for a unit of bananas. Ricardia has a labour endowment of 120 labour hours, while Marxia has an endowment of 60 labour hours. Consumers in both countries have the same preferences for apples and bananas, de- scribed by the utility function U(DA,DB) = DADB, where DA and DB are consumptions of apples and bananas.
(a) Which country has an absolute advantage in each good? Which country has a comparative advantage in each good? In the absence of trade, what will be the relative price of apples in each country?
(b) Construct the world relative supply curve of apples, and graph it.
(c) Derive the world relative demand curve for apples, and graph it on the same diagram in part (b).
(d) What is the equilibrium relative price of apples when two countries trade with each other?
(e) Describe the pattern of trade between Ricardia and Marxia, i.e., who produces, exports and imports what, and how much? Are your results consistent with Ricardian theory?
N.B.: You need to calculate the amount of apples and bananas that each country pro- duces, consumes and exports/imports. For this part, you may assume for simplicity that the world price of bananas is normalized to unity. Show your calculations.
