Consider a Ricardian model whe
Consider a Ricardian model where there are two goods: apples andbananas. For simplicity we will only consider one country calledAlba (that is we will not think about its trading partner (orpotential trading partner)). In Alba the unit labour requirementfor an apple is 20 hours and for a banana is 10 hours. Alba has anendowment of 1000 hours of labour. Draw a production possibilityfrontier (PPF) diagram for Alba. Apples must be on the verticalaxis and bananas must be on the horizontal axis. Suppose that ifAlba does not allow its citizens to engage in international tradeit will produce and consume 25 apples and it will produce andconsume 50 bananas. Show this point on your diagram and label itPCA. Now suppose that Alba does allow its citizens to engage ininternational trade and the world price is 1 banana for 2 apples.Show on your diagram how many apples and how many bananas areproduced in Alba; please label this point as PT. With internationaltrade 80 apples and 60 bananas are consumed in Alba; please labelthis point as CT on the budget constraint. Finally, on your diagramlabel the quantity of exports and label the quantity of imports. Onyour diagram make sure that you state the quantities of exports andimports
Answer:
In Alba the unit labour requirement for an apple is 20 hours andfor a banana is 10 hours. Alba has an endowment of 1000 hours oflabour.
If Alba decides to put all its labour in the production ofapples, then the maximum apples that it can produce = total hoursof labour/time taken to produce 1 apple = 1000/20 = 50
If Alba decides to put all its labour in the production ofbananas, then the maximum bananas that it can produce = total hoursof labour/time taken to produce 1 banana = 1000/10 = 100
If Apples are on the vertical axis and bananas on the horizontalaxis, then the two points on the PPF of Alba are (0,50) and(100,0). PPF of Alba is plotted in figure 1.
If Alba produces and consumes 25 apples and 50 bananas,coordinates of Point PCA are (50,25). It is labelled as point PCAin figure 1.
Now suppose that Alba does allow its citizens to engage ininternational trade and the world price is 1 banana for 2apples.
Opportunity cost of banana in Alba = slope of PPF = 1/2apple
world price is 1 banana for 2 apples. So, the opportunity costof 1 banana in world = 2 apples. (since price reflects theopportunity cost)
Since Alba has a lower opportunity cost of producing bananas,according to comparative advantage theory, it should specialize inthe production of Bananas only. Therefore, bananas produced by Alba= 100 units. This has been marked as point PT in figure 1.
With international trade 80 apples and 60 bananas are consumedin Alba, this point (60,80) is labelled as CT in figure 1. Albamakes 100 bananas and then trade 40 bananas for 80 apples,consuming the remaining 60 bananas. So Alba exports 40 units ofbanana and imports 80 units of apples. Exports and imports aremarked in figure 1.
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