2. Consider problems 3-7 from chapter 2
Consider the following model of trade between
Iceland and Finland. Assume throughout that those
two countries are the only two countries in the
world, at least for purposes of trade. There are two
goods: fish and wheat. Consumers always spend
one fifth of their income on fish and the remainder
on wheat. The only factor of production is labor.
Each Icelandic worker can produce 1 unit of fish or
1 unit of wheat per unit of time, while each Finnish
worker can produce 2 units of fish or 4 units of
wheat per unit of time. There are 1 million workers
in Iceland and 1.5 million in Finland.
(10)
3. Which country has an absolute advantage in fish?
In wheat? Which country has a comparative
advantage in fish? In wheat?
4. Find the autarky relative price of fish in both
countries (i.e., the price of fish divided by the
price of wheat), and draw the typical worker's
budget line in both countries.
5. Derive the relative demand curve relating the
relative demand for fish to the relative price of
fish. Solve algebraically, and then draw the curve
in a diagram with the relative price of fish on the
vertical axis and the relative quantity of fish on
the horizontal axis.
6. Derive the world relative supply curve and draw
it on the diagram that you created in Problem 5.
7. Compute the equilibrium relative price of fish
under free trade, and draw the budget lines for a
typical worker in each country. Which country
produces which good or goods? Is there complete
specialization? Who gains from trade?
