Suppose there are two countries Peru and Japan that produce Food and Fuel. Peru can produce 7,523 units of Food or 17,853 units of Fuel using a labour force of 8000. Japan can produce 5,733 units of Food or 24,156 units of Fuel using a labour force of 5000.
(a) On two separate graphs sketch the initial PPF for the two countries with Food on the x-axis.
(b) If Japan and Peru employ half its workers to produce Food and half to produce Fuel how much of each good can they consume? Label this point A and A* respectively.
(c) Which country has the absolute advantage in food? In fuel? Explain.
(d) Which country has the comparative advantage in food? In fuel? Explain.
(e) Which good(s) should each country specialize in?
(f) Calculate the gains from trade from specialization.
(g) If the terms of trade is 2 to 1 in favour of the country with the comparative advantage in food. Determine the combination of the two goods that each country will consume after trade if the country with the comparative advantage in fuel imports 4000 units of food. Label this point B and B* respectively.
h) Who gains from trade? Who loses? What is the impact if any on the world?
(i) What should the terms of trade be to make trade beneficial for BOTH Japan and Peru? Explain.