Consider a Home production of TVs (the final good) including
R&D and component produc- tion. (a) Draw a hypothetical PPF for
the Home company (component on the horizontal axis and R&D on
the vertical axis). Let (PC/PR) be the relative price of components
in the absence PR of offshoring. Choose a point on the PPF and call
it an equilibrium in the absence of offshoring and draw a line
reflecting (PC/PR). (b) Now consider an equilibrium with offshoring
for which the world relative price of components is (PC/PR)^W.
Illustrate the gains from outsourcing if Home has a comparative PC
PC W1 advantage in component production, that is, (PC/PR) <
(PC/PR)^W1. (c) Now suppose that the relative price of components
rises further, that is, (PC/PR)^W1 < (PC/PR)^W2. Are terms of
trade improved or worsened? Illustrate the impact of this change in
terms of trade on the production of TVs on your diagram.

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