3. Suppose the amount of capital in country F increases.i. Using a diagram show how the world relative supply for good B and the world relative price ofgood B changes.ii. How does it affect the terms of trade of country F?iii. How does it affect the terms of trade of country H?iv. How does it affect the welfare of country F?v. How does it affect the welfare of country H?
Question
- Suppose the amount of capital in country F increases.i. Using a diagram show how the world relative supply for good B and the world relative price ofgood B changes.ii. How does it affect the terms of trade of country F?iii. How does it affect the terms of trade of country H?iv. How does it affect the welfare of country F?v. How does it affect the welfare of country H?
Solution
i. World Relative Supply and Price Changes:
- Draw a graph with the relative price of Good B on the y-axis and the relative quantity of Good B on the x-axis.
- Draw an initial world relative supply curve. This curve is upward sloping, indicating that as the price of Good B increases, the quantity supplied also increases.
- When the amount of capital in country F increases, the production of Good A (which is capital-intensive) increases. However, since Good B is labor-intensive, the increase in capital does not significantly affect its production. Therefore, the world relative supply curve for Good B does not shift significantly.
- As the supply of Good B remains relatively stable, the relative price of Good B does not change significantly.
ii. Effect on Terms of Trade for Country F: The terms of trade is the rate at which one good can be exchanged for another. With an increase in capital, country F can produce more of Good A. However, since the production of Good B does not change significantly, the terms of trade for country F (the amount of Good A it gets for each unit of Good B) does not change significantly.
iii. Effect on Terms of Trade for Country H: For country H, which is a net importer of Good B, the stable price of Good B means that its terms of trade (it can get the same amount of Good B for each unit of Good A it gives up) remain relatively stable.
iv. Effect on Welfare of Country F: The welfare effect on country F is likely to be positive. It can produce and consume more of Good A due to the increase in capital. Since the terms of trade do not change significantly, it can still get the same amount of Good B for each unit of Good A it exports. This increases the welfare of country F.
v. Effect on Welfare of Country H: For country H, the welfare effect is likely to be neutral. It can still import Good B at the same price, which allows it to consume the same amount of both goods. Therefore, the welfare of country H does not change significantly.
Similar Questions
Assume two countries: H and F. Each country produces two goods, A and B. Good A is relatively capitalintensive and country F is relatively labor abundant. Consider H and F to be large economies.1. Suppose the amount of labor in country F increases. Using a diagram show how the PPF and theproduction point of country F change.2. Suppose the amount of labor in country F increases.i. Using a diagram show how the world relative supply for good B and the world relative price ofgood B changes.ii. How does it affect the terms of trade of country F?iii. How does it affect the terms of trade of country H?iv. How does it affect the welfare of country F?v. How does it affect the welfare of country H?
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