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Consider a Ricardian model. There are two countries called Dalriada and Pictland and two goods called apples and bananas. In Dalriada the unit labour requirement for an apple is 6 hours and for a banana is 12 hours. In Pictland the unit labour requirement for an apple is 4 hours and for a banana is 1 hour. Dalriada has an endowment of 3600 hours of labour. Pictland has an endowment of 400 hours of labour.
1 Draw a production possibility frontier (PPF) diagram for Dalriada and a PPF diagram for Pictland. Apples must be on the vertical axis and bananas must be on the horizontal axis. (2 marks)
2 For both countries state the opportunity cost of producing an apple. (2 marks)
3 Suppose now that we have trade between the countries and the world price is 2 bananas for 1 apple. Using PPF diagrams and a short explanation, argue that trade leaves both countries better off. What you do, for both countries, is to arbitrarily select a consumption/production bundle on the PPF and call this bundle X. Then, for both countries, you can show that with trade a consumption bundle (call this Y) can be reached which is unambiguously better than bundle X. Use the uncontroversial assumption that more apples are always preferred to less apples and more bananas are always preferred to less bananas. (4 marks)
4 Denote the world prices in dollars asAPandBPrespectively. Denote the respective quantities of apples and bananas consumed in Dalriada (following trade, of course) asADandBD. Using this notation, write out an expression for the value of consumption in Dalriada. (2 marks)
5 Write out the budget constraint for Dalriada. That is, set the value of consumption equal to the value of production. (2 marks)
6 Rearrange the budget constraint, showing all the steps, so that it is written asBABADPPD−=600 . (2 marks)
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7 While the ratio of prices is apparent from Question 3, we will assume from here on that2$=APand1$=BP. If 300 bananas are consumed in Dalriada, how many apples will be consumed in Dalriada? Now if only 200 bananas are consumed, how many more apples will be consumed? (2 marks)
8 For both countries calculate the hourly wage rate. (2 marks)
9 Why is the wage rate higher in Pictland? (2 marks)
[TOTAL MARKS AVAILABLE: 20
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