Description

Comparative Advantage and Trade Patterns 

The world economy consists of two countries, S (South) and N (North). Both countries use labor to produce wine and rice. The following table describes the amount of labor required for producing each unit of sectoral outputs.

The product and the labor markets are perfectly competitive. In country S, the total labor endowment is 600 and workers prefer to consume wine and rice in the constant proportion of 1:2. Let Cw and Cr denote the consumption of wine and rice in country S. The optimal consumption path (OCP) can be characterized as Cr =2Cw. Wine is taken as the numeraire.

(a) Suppose that country S is initially under autarky. Calculate the price of rice and specify the production possibility curve (PPC). Calculate the sectoral production and consumption. Show your results graphically. 

(b) In which product does country S have an absolute advantage over country N? According to Adam Smith’s theory, which product should country S export? In which product does country S have a comparative advantage over country N? According to David Ricardo’s theory, which product should country S export? 

(c) The labor endowment of country N is far larger than that of country S. Suppose that wine and rice are now freely traded between the two countries. How much is the world price of rice? Calculate the sectoral production and consumption in country S. Use the PPC, t