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Question

# (Adapted from Krugman 7th Edition, Ch. 3: #1-3) Home has 200 units of labor in its

economy. It can produce only two goods, milk (M) and wool (W). The unit labor requirement

in milk production is 2, while in wool production the unit labor requirement is 4.

a) Graph Home's PPF.

b) What is the opportunity cost of milk?

c) Assume that Home is closed to trade (i.e., in autarky). Furthermore, assume Home

consumers' derive no utility if only one good is produced. What would the relative price

of milk be? How do we know for certain that this is the autarky price?

d) Now assume that an adventurous citizen of Home sails off on a raft and discovers another

economy, Foreign. After meeting with the tribal leaders of Foreign, the sailor informs the

Home government that Foreign has a work force of 100. As it turns out, Foreign's

economy also only produces milk and wool. The unit labor requirement for milk in

Foreign is 4 and for wool it is 5. Graph Foreign's PPF.

e) Given this information for Home and Foreign, graph the world relative supply curve.

Clearly label both axes and intercepts.

f) The world relative demand curve takes the following form: The relative demand for milk

in terms of wool = 2 - (price of milk / price of wool). Graph the relative demand curve.

g) What is the equilibrium relative price of milk?

h) Describe the pattern of trade.

i) Demonstrate graphically the gains from trade for Home and Foreign.

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