Question

Ricardian model

I. Mexico has a total supply of labor hours of 900 and Spain has a total supply of labor hours of1200. The following table provides information on the unit-labor requirements in each country.

Bananas Strawberries
Spain 10 labor hrs/unit 4 labor hrs/unit
Mexico 6 labor hrs/unit 6 labor hrs/unit
         
1. Graph the Production Possibility Frontier for the Mexico and Spain economies.
2. Determine the opportunity cost of bananas in terms of strawberries.
3. In autarky, determine the relative prices in both countries. Explain briefly.
4. Which country has comparative advantage in producing strawberries? Which country has absolute advantage in producing strawberries?
5. Are there any gains from specialization? If so, which is the pattern of trade?
6. In free trade, what do you know about the price of bananas relative to strawberries?
7. Suppose the relative free trade price of bananas to strawberries is 2 strawberries per banana. Show graphically and explain how this pattern of specialization, and hence trade, is beneficial to each country.
II. For each exercise, start from the data in the exercise above. Redraw Spain’s PPF for each of the following changes in productivity or resource. Does the pattern of comparative advantage and thus trade change? Why or why not?

1. Productivity triples in the Spain’s banana sector
2. Productivity is cut in half in both the Spain strawberries and banana sectors
3. Spain’s labor endowment doubles.

III. In 1975, wage levels in South Korea were roughly 5% of those in the United States. It is obvious that if the United States had allowed South Korean goods to be freely imported into the United States at that time, this would have caused devastation to the standard of living in the United States, because no producer in this country could possibly compete with such low wages.

Discuss this statement in the context of the Ricardian model.

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Ricardian Model

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