Consider a world of just two countries: Finland and Sweden. And they produce two goods: fish and wheat, using only labour. Each worker in Finland can produce 1.5 unit of fish or 1 unit of wheat per unit of time, while each worker in Sweden can produce 1 unit of fish or 1 unit of wheat per unit of time. There are 1 million workers in Finland and 1.2 million in Sweden, and people in both countries work the same units of time per year. All workers in both countries have the same consumption preference, spending half of their incomes on fish and the other half on wheat.
1) Which country has an absolute advantage in fish? In wheat? Which country has a comparative advantage in fish? In wheat?
2) Draw the production possibility frontier (PPF) curves for both countries and find the autarky relative price of fish in both countries (e.g. the price of fish divided by the price of wheat). [Hint: label x-axis as fish quantity]
3) Suppose now we allow for free trade between these two countries, and the world price of fish relative to wheat is 0.8. Now re-draw the budget lines for both countries. In the free trade world, who produces fish? And who produces wheat?
4) What is the trade pattern and who gains from the trade, why?
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