Consider two countries (Home and Foreign) that produce goods 1 (with labour and capital) and 2 (with labour and land) according to the production functions listed below (Table 1 and Table 2). Initially, both countries have the same supply of labour (100 units each), capital, and land. The capital stock in Home then grows. This change shifts out both the production curve for good 1 as a function of labour employed (Table 1) and the associated marginal product of labour curve (Table 2). Nothing happens to the production and marginal curves for good 2.
a.Show how the increase in the supply of capital for Home affects its production possibility frontier.
b.Draw the relative supply curve for both the Home and the Foreign economy.
c.If those two economies open up to trade, what will be the pattern of trade (i.e., which country exports which good)?
d.Describe how opening up to trade affects all free factors (labor, capital, land) in both countries.
Sample Solution
