Answer Key 1
Comparative Advantage
Econ 101
Professor Guse
Al and Carl both like to consume wine and bread and both are capable of producing wine and
bread. Carl can make up to 60 loaves of bread per month. For each bottle of wine he makes his
bread ouput drops by a 21 loaf. Al can make up to 20 bottles of wine per month. For each loaf of
bread he bakes his wine output decreases by a 12 bottle.
1. Draw Al’s monthly production possibility frontier - the set of output combinations he his
capable of producing.
2. Suppose Al is currently producing and consuming on his PPF making 10 bottles of wine per
month.
(a) Mark this point in your picture of Al’s PPF. ANSWER: See figure 1.
(b) How many loaves of bread does Al bake each month? ANSWER: 20 loaves. See figure
1.
(c) What is Al’s opportunity cost of increasing his wine output by 1 bottle to 11 / month?
ANSWER: 2 loaves for each extra bottle of wine he makes. This is because Al’s PPF
has a slope of 2 loaves per bottle everywhere.
(d) What is Al’s opportunity cost of increasing his bread output by 1 loaf per month?
ANSWER: The inverse of the previous answer - 12 bootle of wine per loaf.
3. Draw Carl’s monthly production possibility frontier - the set of output combinations he his
capable of producing.
4. Suppose Carl is currently producing and consuming on his PPF making 20 bottles of wine
per month.
(a) Mark this point in your picture of Carl’s PPF. ANSWER: See figure 1.
(b) How many loaves of bread does Carl bake each month? ANSWER: 50 Loaves. See
figure 1.
(c) What is Carl’s opportunity cost of increasing his wine output by 1 bottle per month?
ANSWER: 21 loaf for each extra bottle he makes. This is because Carl’s PPF has a
slope of 12 loaf per bottle everywhere.
(d) What is Carl’s opportunity cost of increasing his bread output by 1 loaf per month?
ANSWER: The inverse of the previous answer - 2 bootles of wine per loaf.
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60
Carl’s No Trade Point
50
Bread
(loaves)
40
CARLs PPF
AL’s No-Trade
Point
20
AL’s PPF
10
20
40
60
80
100
120
Wine
(bottles)
Figure 1: Without trading, both players are producing and consuming on their individual PPFs.
Al Wine
Al Bread
Carl Wine
Carl Bread
Table 1: Production, Trade and Consumption Plan for Al and Carl.
Original
Original
Output
New
Trade
Final
Output Consumption Change Output Gain Consumption
10
10
-10
0
+15
15
20
20
+20
40
-15
25
20
20
+20
40
-15
25
50
50
-10
40
+15
55
5. Draw Al and Carl’s combined PPF and mark the current production and consumption point.
ANSWER: See Figure 2.
6. Propose and production and distribution scheme in which both Al and Carl are still producing
on their individual PPF and can each increase their consumption of both goods by one unit.
Mark this point in your combined PPF diagram. ANSWER:. Figure 2 illustrates how total
output can grow in both goods. As we see in the diagram, one possibility is to have Al give
up wine-making and make 40 loaves of bread while having Carl produce 20 more bottles of
wine and 10 fewer loaves of bread. As seen in the diagram, these changes lead to higher
output of both good - 10 more bottles of wine and 10 more loaves of bread. Table 1 shows
one production and trade or distribution plan that splits the gain in output of each good
evenly achieving 5 more units of both for both agents. Many possibilities here.
7. Answer question 1 in “Test Yourself Questions” at the end of Chapter 3 in the Baumol and
Blinder Text:
A person rents a house for which she pays the landlord $12,000 per year.
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Al’s Original Output
Al’s New Output after specialization.
100
Vector of Al’s Change in Output
Combined Output
Al completely
Specializes
80
Carl’s Change in Output
Combined Output
NO TRADE
70
60
Combined PPF
Carl’s No Trade Point
50
Bread
(loaves)
40
CARLs PPF
AL’s No-Trade
Point
20
AL’s PPF
10
20
30
40
120
50
140
Wine
(bottles)
Figure 2: By specializing in their respective comparative advantage production activities, total
output in both goods can be increased. In this example, Al completely specialized in Bread production moving along his individual PPF from (10, 20) (in green) to (0, 40) (in red). Meanwhile,
Carl specialized in wine (though not completely so) producing twenty more bottles of wine and
10 fewer loaves of bread. This change is represented by a movement along his individual PPF
(highlighted in blue). Due to specialization Al and Carl can increase their combined output of both
goods moving from (30, 70) to (40, 80).
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Lost Interest
Taxes & Maintenence
Rent
Total
Table 2: Cost of renting versus homeownership.
Own
Rent
$4000
$0
$X
$0
$0
$12000
$ (4000 + X) $12000
The house can be purchases for $100,000, and the tenant has this much
money in a bank account earning 4% interest. Should she buy? Explain
using opportunity cost.
ANSWER: Assume that the house will always be worth $100,000 (no appreciation and no
depreciation) and that annual property taxes and maintenance on the house add up to X.
Assume also that rent is collected at the end of the lease. (This won’t make too much of
a difference.) Now consider renting. This would entail keeping the $100,000 in the bank,
earning $4,000 in interest and paying $12,000 in rent. At the end of the year the renter
would have total assets of $92,000. Next consider buying. In this case the $100,000 is spent
to purchase the house, no rent is paid, and the owner-resident is responsible for taxes and
maintenance of X. At the end of the year, the owner’s total assets are $100,000 - X. Hence
as long as the annual out-of-pocket expenses (property taxes and maintenance) do not exceed
$8,000, it is worth buying. The opportunity cost of buying consists on the property taxes,
maintenance expenses AND lost interest ($4,000). The opportunity cost of renting is the lost
rent ($12,000).
8. This question is adapted from Jeffrey Perloff’s text Microeconomics. Two countries, the U.S.
and France, can produce food and handbags. France has 100 workers and the U.S. has 300
workers. The following table shows the labor requirements for each good in each country.
Workers per ton of food
Workers per handbag
France
10
50
U.S.
10
20
(a) Draw the individual PPF for each country. Identify comparative advantages. ANSWER. See Figure 3. To make a ton of food the U.S. needs 10 workers. Pulling those
10 worker out of handbag production would cost 12 handbag (since it take 20 workers
to make 1 whoel handbag). Meanwhile in France it also take 10 worker to make 1 ton
of food. However, in France pulling those 10 workers out of handbag production would
only cost 51 handbag. Therefore France has the comparative advantage in food (while
the U.S. has the c.a. in handbags).
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Table 3: Production and Consumption Plan for France and U.S
Original
Original
New
New Labor
Final
Output Labor Force Output
Force
Consumption
France Food
5
50
10
100
5.5
France Handbags
1
50
0
0
1.5
U.S. Food
10
100
6
60
10.5
U.S. Handbag
10
200
12
240
10.5
(b) Suppose that in the absence of trade (autarky), the U.S. produces and consumes 10 tons
of food while France produces and consumes 5 tons of food. Assuming full employment,
what is the handbag output in each country? Mark the appropriate point on each
country’s PPF and describe how many workers in each country are employed in each
industry. ANSWER See Figure 3 and the “original labor force” column in Table 3.
(c) Draw the combined PPF and show that both countries can benefit from trade by proposing an outcome in which both countries end up consuming more food and more handbags. ANSWER. In Figure 3 the red points represent the original production and
consumption points. The green points represent one possible production plan that allow
an increase in the two countries output of both goods. In the green-dot example, the
U.S. reduces food output by 4 tons and increasing handbag output by 2 while France
increases food output by 5 tons and reduces handbag output by 1.
(d) How many workers in the U.S. have to be retrained? ANSWER. To achieve the handbag output increase of 2 handbags in the U.S., 40 workers get transfered from the farms
to the factories resulting in the 4 tons reduction in food ouput we see in the diagram
and no doubt causing some disruption and requiring retraining.
5
17
15
U.S. Output
after Spec’n
Combined Output
Post Specialization
Handbags
12
11
Combined Output
No Trade
10
US Output
No Trade
Combined
PPF
U.S
PPF
French PPF
2
French Output
No Trade
1
French Output
after Specialization
5
10
15
30
40
16
Food
Figure 3: Individual and Combined PPFs for the U.S. and France in Food and Handbags.
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