PROBLEM SET 2
PUGEL 14, “Questions and Problems,” pp. 46-48: #1*, 2, 3*,
7*, 8, 10
*Answers in the back of textbook
ADDITIONAL PROBLEMS
1.
The following table shows the amount of labor it takes to
produce goods X and Y in countries A and B.
Labor hours to make 1X
Labor hours to make 1Y
Labor hours available
Y
Country A
4
8
200
Country B
5
4
100
a.
Which country has absolute advantage in X? In Y?
b.
Which country has comparative advantage in X? In Y?
c.
Label the endpoints on each country’s PPC below.
Y
12.5
0
A
25
COUNTRY A
12.5
X
A
10
X
COUNTRY B
What do the endpoints of the PPC tell us? Find the slope of each
country’s PPC. What does the slope of the PPC tell us?
d.
Suppose that with no trade, each country produces and
consumes at point A on its PPC. When trade is opened, which country
2
exports which good? If the equilibrium international price ratio (or
terms of trade) is 1 Y per 1 X, what happens to production in each
country? Label the free-trade production point on each country’s PPC.
e.
In this free-trade equilibrium, 12.5 X and 12.5 Y are
traded. What is the consumption point in each country with free
trade? Label this point on each country’s PPC.
f.
Does each country gain from trade? Explain, referring to
your graphs as is appropriate.
2.
The following table shows the amount of labor it takes to
produce goods X and Y in countries A and B.
Labor hours to make 1X
Labor hours to make 1Y
Labor hours available
Country A
4
2
200
Country B
5
4
300
a.
Which country has absolute advantage in X? In Y?
b.
Which country has comparative advantage in X? In Y?
c.
Label the endpoints on each country’s PPC below.
Y
Y
50
A
25
COUNTRY A
50
X
A
20
COUNTRY B
What do the endpoints of the PPC tell us? Find the slope of each
country’s PPC. What does the slope of the PPC tell us?
X
3
d.
Suppose that with no trade, each country produces and
consumes at point A on its PPC. When trade is opened, which country
exports which good? If the equilibrium international price ratio (or
terms of trade) is 1.5 Y per 1 X, what happens to production in each
country? Label the free-trade production point on each country’s PPC.
e.
In this free-trade equilibrium, 33 X and 50 Y are traded.
What is the consumption point in each country with free trade? Label
this point on each country’s PPC.
f.
Does each country gain from trade? Explain, referring to
your graphs as is appropriate.
3.
The following table shows the amount of labor it takes to
produce goods X and Y in countries A and B.
Labor hours to make 1X
Labor hours to make 1Y
Labor hours available
a.
Country A
2
6
60
Country B
5
15
300
Which country has absolute advantage in X? In Y?
b.
Which country has comparative advantage in X? In Y?
Which country will export which good if free trade is allowed between
the two countries?
SELECTED ANSWERS
PUGEL 14, pp. 46-48 (Answers to odd-numbered problems are
in the back of the textbook)
2.
Agree. Imports permit the country to consume more. Anything
that is exported is not available for domestic consumption. Although
this loss is bad, exports are like a necessary evil because exports are
how the country pays for the imports it wants.
8.
a.
Moonited Republic has an absolute advantage in wine – it
takes fewer labor hours to produce a bottle of wine (10 < 15).
Moonited Republic also has an absolute advantage in producing cheese
– it takes fewer labor hours to produce a kilo of cheese (4 < 10).
b.
Vintland has comparative advantage in wine – the
opportunity cost of producing 1 bottle of wine in Vintland is 1.5 kilos of
4
cheese, which is less than that in Moonited Republic (2.5 kilos of
cheese). Moonited Republic has a comparative advantage in
cheese – the opportunity cost of producing 1 kilo of cheese in
Moonited Republic is 0.4 bottle of wine, which is less than that in
Vintland (0.67 bottle of wine).
c.
Wine (mil. of bottles)
Wine (mil. of bottles)
2
2
1
I1
A
A
I1
0
1.5
VINTLAND
3
Cheese
(mil. of kilos)
0.8
0
3
5
Cheese
(mil. of kilos)
MOONITED REP.
d.
When trade is opened, Moonited Republic exports cheese
and Vintland exports wine. If the equilibrium international price ratio
(terms of trade) is 0.5 (1/2) bottle of wine per kilo of cheese, Moonited
Republic will specialize completely in producing cheese, and Vintland
will specialize completely in producing wine.
e.
With free trade Moonited Republic produces 5 (=20 mil.
hours/4 hours per kilo) million kilos of cheese. If it exports 2 million
kilos, then it consumes 3 million kilos of cheese. It consumes 1
million bottles of wine that it imports. With free trade Vintland
produces 2 (=30 mil. hours/15 hours per bottle) bottles of wine. If it
exports 1 million bottles of wine, then it consumes 1 million bottles
of wine. It consumes 2 million kilos of cheese that it imports.
5
Wine (mil. of bottles)
Wine (mil. of bottles)
2
2
1
B
I1
0
1.5 2
I2
3
Cheese
(mil. of kilos)
VINTLAND
I1 I2
1
0.8
0
B
3
5
Cheese
(mil. of kilos)
MOONITED REP.
f.
Each country gains from trade. Each is able to consume
combined quantities of wine and cheese that are beyond its ability to
produce domestically. (The free trade consumption point (B) is
outside of the production possibilities curve.). Each reaches a higher
indifference curve  higher utility (I2 > I1).
10.
If the number of labor hours to make a bushel of wheat in the
U.S. is reduced by half to 1 hour, this reinforces the U.S.
comparative advantage in wheat. (In fact, the United States
then has an absolute advantage in wheat). The United States
is still predicted to export wheat and import cloth.
If, instead, the number of hours to make a yard of cloth is
reduced by half to 2 hours, this reduces the U.S. absolute
disadvantage in cloth, but it does not change the pattern of
comparative advantage. The opportunity cost of producing a
yard of cloth is now 1 bushel of wheat, but this is still higher
than the opportunity cost producing a yard of cloth (0.67
bushels of wheat) in the rest of the world. The United States
still has a comparative advantage in wheat, so the United
States is still predicted to export wheat and import cloth.
6
ADDITIONAL PROBLEMS:
1.
a. Country A has absolute advantage in X; Country B has
absolute advantage in Y.
b.
A
½ (.5) Y
2X
Opp. Cost of 1X
Opp. Cost of 1Y
B
1 ¼ (1.25) Y
4/5 (.8) X
Country A has comparative advantage in X and Country B has
comparative advantage in Y.
Y
c.
25
Y
25
slope=ΔY/ΔX= -½ (-.5)
12.5
0
A
25
COUNTRY A
12.5
50
X
slope=ΔY/ΔX=-1 1/4
=-1.25
A
10
20
X
COUNTRY B
The endpoints tell us how much of the good on that axis can be
produced if the country produces only that good. The slope tells us
the opportunity cost of the good on the horizontal axis (in this case,
the opportunity cost of good X).
d.
Country A exports X and Country B exports Y. Each country will
specialize in the production of the good for which it has comparative
advantage: A will produce only X and B will produce only Y.
7
Y
Y
Production with free trade
25
25
12.5
A
BP
12.5
A
BP
0
25
50
X
10
COUNTRY A
20
X
COUNTRY B
e.
Y
Y
BP
25
25
12.5
A
BC
12.5
A
BC
BP
0
25
COUNTRY A
37.5 50
X
10 12.5 20
X
COUNTRY B
Each country consumes at point BC on its respective PPC. A consumes
12.5 Y (imported) and 37.5 X (50 X produced – 12.5 exported). B
consumes 12.5 X (imported) and 12.5 Y (25 Y produced – 12.5
exported).
f.
With free trade, each country consumes a combination (BC)
which is above or outside its PPC. Therefore, each country gains from
trade.
8
2.
a.
Country A has absolute advantage in both goods.
b.
A
2Y
1/2 (.5) X
Opp. Cost of 1X
Opp. Cost of 1Y
B
1 ¼ (1.25) Y
4/5 (.8) X
Country A has comparative advantage in good Y and Country B has
comparative advantage in good X.
c.
Y
Y
100
75
slope= ΔY/ΔX = - 2
50
A
25
COUNTRY A
50
50
X
slope= ΔY/ΔX
= - 1 1/4
A = - 1.25
20
60 X
COUNTRY B
The endpoints tell us how much of the good on that axis can be
produced if the country produces only that good. The slope tells us
the opportunity cost of the good on the horizontal axis (in this case,
the opportunity cost of good X).
d.
Country A exports Y and Country B exports X. Country A will
produce Y and Country B will produce X.
9
Y
Y
100
BP
Production with trade
50
75
A
50
A
BP
25
COUNTRY A
50
X
e.
Y
100 BP
20
60 X
COUNTRY B
Y
75
50
A
BC
50
A BC
BP
25 33
COUNTRY A
50
X
20 27
60 X
COUNTRY B
Each country consumes at point BC. Country A consumes 33 X
(imported) and 50 Y (100 produced – 50 exported). Country B
consumes 27 X (60 produced – 33 exported) and 50 Y.
f.
With free trade, each country consumes a combination (BC)
which is above or outside its PPC. Therefore, each country gains from
trade.
10
3.
a.
Country A has absolute advantage in both goods.
b.
Opp. Cost of 1X
Opp. Cost of 1Y
A
1/3 (.33) Y
3X
B
1/3 (.33) Y
3X
Since the opportunity costs are the same in both countries, neither
country has comparative advantage. No trade will occur because the
opportunity costs must be different for the two countries to gain from
trade.