1. Trading Cities—50 Points
The Table below summarizes the productivity of workers in bread and shirt production in two parts of a region.
Output per Hour Opportunity Cost
East West East West
Bread 1 5
Shirts 3 6
a. Complete the table by providing the opportunity costs of producing bread and shirts in the East and the West. For which good does the East have a comparative advantage? What about the West? (20 Points)
b. Assume that transport costs are zero and that the exchange rate is two shirts for one loaf. If a western household switches one hour from shirt production to bread production and exchanges all the additional bread for shirts, will the household be better off? Why or why not? (10 Points)
c. Suppose that the time required to execute the trade in (b) is one hour. Is trade still beneficial? At what transaction cost (time per trade) would the net gain from trade be zero? (10 Points)
d. Under what conditions will the differences in labor productivity cause the development of cities? (10 Points)
2. Factory Towns—25 Points
A self-sufficient worker can make 1 shirt per hour. A factory uses specialized labor and indivisible inputs to produce 10 shirts per hour. Commuting takes 1/5 of hour per mile round-trip.
a. At what distance from the shirt factory will the price of factory shirts and home produced shirts be equal? (10 Points)
b. Suppose an innovation in transportation technology cuts commuting time in half. At what distance from the shirt factory will the price of factory shirts and home produced shirts be equal now? (10 Points)
c. Suppose the economy described above is located on a linear island 54 miles wide. How many factories will be located on the island? (Note: continue to assume the doubly efficient transport technology in b above). Explain your answer. (5 Points)
