Home » The world economy consists of two regions, North and South, and two goods, manufacturing (good 1) and agriculture (good 2).

# The world economy consists of two regions, North and South, and two goods, manufacturing (good 1) and agriculture (good 2).

1. The world economy consists of two regions, North and South, and two goods, manufacturing (good 1) and agriculture (good 2). In North, producing one unit of manufacturing good requires two units of labor while producing one unit of agricultural good requires one unit of labor. In South, producing one unit of manufacturing good requires five units of labor while producing one unit of agricultural good requires one unit of labor. North has 100 units of labor and South has 150 units of labor. World relative demand for manufacturing good to agricultural good is

where  and are consumption of manufacturing and agricultural goods in the North,  and  are consumption of manufacturing and agricultural goods in the South, and  and  are world prices of manufacturing and agricultural goods.

a)    Construct the equation that describes the production possibility frontier for North. Determine the maximum production of agricultural good and of manufacturing good. What is the North opportunity cost of agricultural good in terms of manufacturing good, and where does it appear in the equation that describes North production possibilities? Draw the graph of North production possibility frontier.

b)   Construct the equations and graphs of consumption possibility frontier for North under the cases of closed economy and free trade. Determine the maximum amount of consumption of agricultural good and of manufacturing good for North in closed economy and under free trade. Where does the free trade relative price of agricultural good to manufacturing good appear in the equations describing consumption possibility frontiers?

c)    Does the North gain from trade? Explain.

d)   What is the world relative price of manufacturing to agricultural goods? Draw the world relative supply and the world relative demand curves (for manufacturing relative to agriculture) and determine the equilibrium as their intersection.

2. Suppose the world consists of two countries: China and Japan, and of two goods: Cars (good 1) and Electronics (good 2). For answering this question, let price of good  be , total labor in country  be , unit labor requirement in country  for good  be .

Use a diagram that has the relative price of cars to electronics, , on the vertical axis, and world relative production (and consumption) of cars to electronics on the horizontal axis, incorporating the world relative demand curve, RD, and the world relative supply curve, RS.

Suppose Japan has a comparative advantage in car production. Initially, the equilibrium relative price  is such that each country specializes in only one good. Suppose in China the unit labor requirement of producing electronics, , decreases; that is, Chinese productivity in electronics rises. Using your diagram, show how the reduction in  changes relative world price of cars to electronics, .

3) To answer this question you are supposed to study “Myths and Realities of U.S. competitiveness” by Paul Krugman, Science 1991 (Uploaded on blackboard).

Here is Krugman’s thought experiment: Imagine a world in which labor productivity around the world grows at annual rate of 1%, both in the U.S. and abroad. It would seem reasonable to suppose that standards of living and real wages would rise by 1% per year everywhere. Now, suppose that U.S. productivity were to continue its 1% growth rate, but that productivity growth in other countries were to accelerate, say to 4% annually. Would the United States be in trouble?

Summarize Krugman’s answer to this question.

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