Suppose England uses land, capital, and labor to produce alfalfa and sweaters. L

Question

Suppose England uses land, capital, and labor to produce alfalfa and sweaters. Land is specific to the production of alfalfa, capital is specific to the production of sweaters, and labor is a mobile factor used in both industries. Suppose that with no international trade, the price of alfalfa in England is $3 per bushel. The graph below shows England’s production possibility frontier (PPF) and indifference curves (U1, U2, U3). previous solutions incorrect

(a) On the graph above, use the X symbol to indicate England’s no-trade equilibrium. (Points: 1)

(b) In no trade equilibrium, the price of alfalfa in terms of sweaters is _________. Since the price of alfalfa is $3.00 per bushel, this means that the price of a sweater must be _________. (Points: 2)

(c) Now suppose England opens to international trade. As a result, the price of alfalfa falls to $1.25 per bushel, while the price of sweaters remains unchanged. Now the relative price of alfalfa in terms of sweaters is __________.  (Points: 1)

(d) On the graph above, use a dashed line to indicate the combination of goods that England produces with trade. Indicate the combination with a symbol Y. Use the dashed line to indicate the combination of goods that the country consumes when it trades. Indicate the combination with a symbol Z. (Points: 2)

(c) When England opens to trade, production of alfalfa in the country _________  (increases/decreases) by ___________  (amount) bushels, and production of sweaters __________ (increases/decreases) by ___________ (amount) sweaters. (Points: 4)

SWEATERS (Millions) 140 120 100 PPF U3 80 U2 60 UT V3 40 20 V2 V1 0 80 160 240 320 400 480 560 ALFALFA (Millions of bushels)

Explanation / Answer

Answer-

a) Budget constraint is the same as the Production Possibility Frontier

Three points on the PPF represent the no-trade equilibrium

b) Total that can be spent = 3*450 = $1350

450 Alfalfa = 110 sweaters

1 sweater = 4.09 Alfalfa

Price of alfalfa = 3 per bushel

Price of sweater = 3*4.09 = 12.27

c) Price of Alfalfa =$1.25 per Bushel

12.27 /1.25 = 9.816

d) Symbol Y combination of goods produced - this is on line V3, and, indifference curve on U2. the production of Alfalfa increases when the country trades.Symbol Z - Point on V1, and, U3.

After trade, the points will be on indifference curve U3, and, budget constraint V1, as prices decrease due to imports, and, England move to a higher indifference curve

e) production of Alfalfa decreases by 20 million bushels; 320 to 300

production of sweaters increases by 40 million; 80 to 120

England moves from U1 to U3

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