ABSTRACT
Figure 2.1(a) depicts a linear PPF, VP. The slope of the PPF is a1/a2. Both goods are produced at Home only if the wages earned in the two sectors are the same. Denote pi the price of good i, wage rate in i-th sector is pi/ai. Then, wage rates are equalized across sectors if and only if
p1___a1 =
p2___a2 . (2.2)
In other words, in autarky (i.e., no international trade), the relative price of good 1 is determined by its opportunity cost:
p A2 =
a1__a2, (2.3)
where superscript A represents the autarky equilibrium. In Figure 2.1(a), the autarky equilibrium might occur at point A. Panel (b) depicts Foreign PPF, P*V* and the autarky equilibrium at A*. Suppose that Home has a comparative advantage in producing good 1, meaning that
a1__a2 < a
Combining this with (2.3) and its Foreign counterpart, the Home autarky relative price of good is lower than Foreign:
< p1 *A ____p2*A .
