Trading and Factory Towns (30%)
1. Consider a town that produces either handbags or apples. We will assume that a factory in this town
has economies of scales in handbag production with factory output (q) = 10 handbags for hour. Also,
assume that factory wages (w) = 2.2 kg apples per hour, and cost of capital (r) = 1.8 kg apples per
hour.
Household on the other hand, can either produce 1 handbag per hour or pick 1 kg apples per hour.
Therefore, for every hour of travel, households have an opportunity cost of 1 kg of apple. We will
assume that it takes households in this town a total of 0.1 hours to travel 1-mile round trip to factory
(so the opportunity cost for 0.1 hours is 0.1 kg of apples).
a. What is the average cost of labor and average cost of capital per hour?
b. What is the price that factory charges for the handbags? Express this in kg of apples.
C. Given the information provided above, what is the size of this factory town?
d. If factory prices for handbags decreases to 0.2 kgs of apples, due to technological progress, what
would be the size of this factory town?
e. Draw a graph depicting original size of the city, and the change in the size of the city after the
drop in price.
