Consider the two countries from Problem A.4 in Problem Set 1, Ausonia (home) and Zambonia (foreign),...
Consider the two countries from Problem A.4 in Problem Set 1, Ausonia (home) and Zambonia (foreign), which produce yogurt and sausages. As we already know from that problem, there is only one factor of production (labor). In order to produce a gallon of yogurt, Ausonian workers need 30 minutes, and Zambonian workers need 1 hour. In order to produce a sausage, Ausonian workers need 1 minute, and Zambonian workers need 3 minutes.Ausonia’s labor endowment is L = 1,500 hours, while Zambonia’s labor endowment is L*=3,000 hours.Markets are perfectly competitive.
Please answer ONLY PART E)
D) Draw the consumption possibility frontiers for Ausonia and Zambonia (in two separate graphs) when there is international trade and the relative price of yogurt is 20 sausages (as in the question above). Are there gains from trade for Ausonia? Why or why not? And for Zambonia? Why or why not?
E) Now assume that the relative demand for yogurt increases, and crosses the world relative supply at a relative price equal to 25 sausages. Draw the new relative demand on a new graph, showing where it crosses the relative supply. Now, draw the new consumption possibility frontiers for Zambonia and Ausonia (in two separate graphs). How do your answers to the previous question change? That is, at this different relative price, are there gains from trade for Ausonia? Why or why not? And for Zambonia? Why or why not? Explain.
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