Question

Assume a world of two goods, beef and cars; and two countries South Africa and Botswana. Cars are capital intensive and Botswana is labour abundant. Assume the standard H-O assumptions hold. According to the Rybczynski theory, if labour doubles in Botswana how does production and consumption compare to pre-growth conditions in Botswana? Explain with the relevant diagram.
b. CMU is a country that produces apples and computers, where computers are capital intensive; CMU’s PPF is bowed out (exhibits increasing relative costs); CMU is capital abundant, and the standard H-O assumptions hold. The other country is SVC.

i. Assume further that CMU is a small country. What is the effect on welfare if labour doubles and capital does not change? What if capital doubles and labour does not change? Use offer curves to support your answers. (12 Marks)
ii. Now assume that CMU is a large country. Evaluate the impact on welfare, associated with an increase in capital with labour held constant. Use offer curves to support your answers.

Answer 1

a)

  

Labour constraint A S, S2 B Capital constraint CA C2 QC

In the graph, red is depicting a labour constraint and blue is depicting a capital constraint. Assume, production occurs initially on PPF at point A.

If labours doubles in Botswana, it will result in outward shift in labour constraint. The production possibility frontier (PPF) including production will shift to point B. Production of beef, the labour-intensive good, will rise from C₁ to C₂. Production of Cars, the capital-intensive good, will fall from S₁ to S₂.