Problems:
Chapter 2; (pp-48-49)
1)
Case A
US
UK
4
1
1
2
W
C

Case B
US
UK
4
1
3
2
Case
US
4
2
C
UK
1
2
Case D
US
UK
4
2
2
1
an absolute advantage and disadvantage;
In Case A,
US have absolute advantage (mutlak üstünlük) in production of Wheat. (4 times of
efficient). And US has absolute disadvantage in production of Cloth.
UK has absolute advantage in production of Cloth (2 times) and UK has absolute
disadvantage in Wheat production.
According to Absolute Advantage Theory, US is specializing in the production of
and exporting Wheat and UK is specializing in the production of and exporting
Cloth.(Complete Specialization and constant opportunity cost)
In Case B,
US have absolute advantage (mutlak üstünlük) in production of Both Commodities.
Because it is 4 times efficient in production Wheat and 1.5 times efficient in production of
Cloth production
UK has absolute disadvantage in production of Both Commodities.
According to Absolute Advantage Theory, mutually benefical trade is not possible.
In Case C,
US have absolute advantage (mutlak üstünlük) in production of Wheat.(4 times of
efficient).
UK has absolute disadvantage in production of Wheat.
Both nations produce some amount of Cloth domestically. (Neither US nor UK has
Absolute Adv. for C production)
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1
In Case D,
US have absolute advantage (mutlak üstünlük) in production of both Commodities.
As it’s 2 times efficient than UK in production of commodities.
UK has absolute disadvantage in production of Both Commodities.
According to Absolute Advantage Theory, mutually benefical trade is not possible.
3)
In Case A,
Trade is possible between the US and UK. US has absolute advantage (mutlak
üstünlük) in production of Wheat. And UK has absolute advantage in production of Cloth.
So the US should specialize in Wheat production and UK should specialize in Cloth
production according to Theory of Absolute and Comparative Advantage.
In Case B,
Although US have absolute advantage in production of both commodities, mutually
beneficial trade is still possible according to Comparative Advantage Theory.
The Comparative (Karşılaştırmalı) Advantage of Wheat production is bigger than
comparative advantage of Cloth production in US. Because,
W/C = 4/3  1/2 in US. And,
The Comparative (Karşılaştırmalı) Disadvantage of Cloth (inefficiency) production is
smaller than comparative disadvantage of Wheat production in UK. Because,
C/ W= 2/1  3/ 4 in UK.
So the US should specialize in Wheat production and UK should specialize in Cloth
production according to Comparative Advantage.
In Case C,
According to Law of comparative advantage, The US has a comparative advantage in
Wheat, while the UK has a comparative advantage in Cloth. Because,
W/C = 4/2  1/2 in US and
C/ W= 2/1  2/ 4 in UK.
So the US should specialize in Wheat production and UK should specialize in Cloth
production according to Comparative Advantage. Trade is possible according to Comparative
Advantage.
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2
In Case D,
The two nations have not a comparative advantage in both of Commodities. Because,
W/C = 4/2 = 2/1 in US and
C/ W= 2/4 = 1/2 in UK.
Mutually beneficial trade is not possible according to comparative advantage. Because
the Us would trade only if it exchange 4w for more than 2c. But The UK would not be
willing to give up more than 2c to obtain 4w from the US.
5)
a) For Case B,
1 man/hour
4
bushels W in US
x
1 bushels W
----------------------------------------x = 1/4 , the cost in terms of labor content of producing Wheat in US.
1 man/hour
3
yards C in US
x
1
yards C
----------------------------------------x= 1/3, the cost in terms of labor content of producing Cloth in US
1 man hour
1
bushels W in UK
x
1 bushels W
----------------------------------------x = 1 , the cost in terms of labor content of producing Wheat in UK.
1 man hour
2
yards C in UK
x
1
yards C
----------------------------------------x= 1/2, the cost in terms of labor content of producing Cloth in UK.
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3
b)
Case B,
in the US, wage rate is 6
$ and 4W, 3C are produced in one man hour.
Pw = 6 $ / 4W =1.5 $ (Price of Wheat in US)
Pc = 6 $ / 3C = 2 $ (Price of Cloth in US)
c)
in the UK, wage rate is 1 £ and 1W, 2C are produced in one man hour.
Pw = 1 £ / 1W=1 £ (Price of Wheat in UK)
Pc = 1 £ / 2C= ½ £= 0.5 £ (Price of Cloth in UK)
-----------------------------------Case B
US
UK
W
C
1.5
2
$
$
1
£
0.5 £
---------------------------------------
6)
a)
When 1 £ = 2 $ ,
The dollar price of Wheat is 2 $ ( 1 £ = 2 $) and The dollar price of Cloth is 1 $ (1 £ =
2 $ and 0.5 £ = 1 $) .
Dollar price of Wheat and Cloth in US and UK.
-----------------------------------Case B
US
UK
W
C
1.5 $
2
$
2 $
$
1
--------------------------------------The Dollar price of Wheat is lower in US, on the other hand, The dollar price of Cloth is
lower in UK, When The Exchange rate is 1 £ = 2 $ . US would be able to export Wheat
and UK would be able to export Cloth at this Exchange rate.
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4
b)
When 1 £ = 4 $ ,
The dollar price of Wheat is 4 $ ( 1 £ = 4 $) and The dollar price of Cloth is 2 $ (1 £ =
4 $ and 0.5 £ = 2 $) .
Dollar price of Wheat and Cloth in US and UK.
-----------------------------------Case B
US
UK
W
C
1.5 $
2
$
4 $
2 $
--------------------------------------The Dollar price of Wheat is lower in US, on the other hand, The dollar price of Cloth equal
both UK and US, When The Exchange rate is 1 £ = 4 $ . US would be able to export
Wheat and UK would not be able to export Cloth at this Exchange rate. So Trade would be
unbalanced in favor of the US, The UK could not export Cloth to the US and the Exchange
rate between dollar and pound would have to fall.
c)
When 1 £ = 1 $ ,
The dollar price of Wheat is 1 $ ( 1 £ = 1 $) and The dollar price of Cloth is 0.5 $ (1 £ =
1 $ and 0.5 £ = 0.5 $) .
Dolar price of Wheat and Cloth in US and UK.
-----------------------------------Case B
US
UK
W
C
1.5 $
2
$
1 $
0.5 $
--------------------------------------The Dollar price of Wheat is lower in UK, on the other hand, The dollar price of Cloth is
lower in UK, When The Exchange rate is 1 £ = 1 $ , UK would be able to export Wheat
and Cloth and US not. So Trade would be unbalanced in favor of the UK, The US could not
export Cloth to the UK and the Exchange rate between dollar and pound would have to rise.
d)
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5
When 1 £ = 1.5 $ ,
The dollar price of Wheat is 1.5 $ ( 1 £ = 1.5 $) and The Dollar price of Wheat is same
both US and UK. So The US would not be able to export Wheat at 1 £ = 1.5 $.
When 1 £ = 4 $ ,
The dollar price of Cloth is 2 $ ( 1 £ = 4 $) and The Dollar price of Cloth is same both US
and UK. So The UK would not be able to export Cloth at 1 £ = 4 $.
The Range of Exchange Rate,
1.5 $ < 1 £ <4 $ .
7)
a)
-----------------------------------Case B
US
UK
W
4
1
C
3
2
---------------------------------------
US
UK
C
C
3
2
b
a
W
4
W
1
b)
tan a = Qc / Qw = 3 / 4 = P w/ Pc or MRT us = C/W= - 3/4 Because, (Pc*Qc=
Pw*Qw).
Pw/Pc= 3/4 in US. (relative price of Wheat)
The slope (absolute) of Production Possibility Frontier ( or tangent) is 3/ 4 in US.
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6
tan b = Qc / Qw = 2/ 1 = P w/ P c or MRT uk = C/W= - 2 , Because, (Pc*Qc=
Pw*Qw).
Pw/Pc= 2/1 in UK. (relative price of Wheat)
c)
Pc/Pw= 4/3 in US. (relative price of Cloth)
Pc/Pw= 1/2 in UK. (relative price of Cloth)
Production Fuctions,
US) Slope = -3/4 and (3,3/4)
………………………………………………..
( y- ¾) = -3/4 (x-3)
y-3/4 =-3/4(x-3)
y-3/4 = -3/4 x + 9/4
y+3/4x = (9+3)/2
4y+3x=12
namely,
4C + 3W = 12
UK) slope = -2 and (1/2 w, 1c)
( y- 1) = -2 (x-1/2)
y-1 =-2x +1
y+2x=2
namely
C+2W=2
…………………..
8)
Case B and Terms of Trade is 1w = 1c.
US
UK
C
C
3
B’
2
1
3/4
E’(1W,1C)
E ( 3w,1C)
1
A
A’
B
3
7
7
4
W
W
1/2
1
Without trade
with trade
W
US
3
UK
1/2
W
US
4
C
3/4
1
C
0
after trade
UK
0
US
W 3
2
C
1
UK
1
1
(complete Specialization)
for US,
Point A) shows the bundle of commodities that Us produce and consumes in absence of trade.
Point B) shows how much wheat the US produces when it specializes (complete),
Point E) When US Exchange 1w for 1 c its consumption ends at point E.
For UK,
Point A’) shows the bundle of commodities that UK produce and consumes in absence of
trade.
Point B’) shows how much cloth the UK produces when it specializes (complete),
Point E’) When UK Exchanges 1w for 1c its consumption ends at point E’.
And it gains,
US gains
0W
¼ C
UK gains
½ W
0 C
---------------------------------------------------or in other way,
Without trade
with trade
W
US
3
UK
½ =3.5 (total W)
C
3/4
1 = 1.75 (total C)
Gains
4 w – 3.5 W= 0.5 W
2c-1.75 = 0.25 C
8
8
W
C
US
4
0
UK
0 = 4 (total W)
2
= 2(total C)
9)
(see. Figure, 2-2 and 2-3)
Pw/Pc
Sw (US, UK)
2
4/3
1
C
E
Dw’
Dw(US,UK)
2/3
180
240
W
US ) Pw/Pc = 2/3
UK ) Pw/Pc = 2
US
UK
Terms of Trade = 1w = 1c
W = 180
W
= 60
240 = 60 + 180
………………………………………
a)
If Dw shifted up by one-third,
The equilibrium- relative commodity price of wheat is 1 + 1/3 = 4/3,
Pw/Pc =4/3 or 4C = 3W.
The Wheat production is 180 in US after demand shift, and The Cloth production is 120 in
UK. The Consumption and gains for trade change (constant opp. Cost). The US’s gain for
trade increases, Because, The US exchange 3w for 4c in the terms of trade 4C=3W, it is more
(C or gain) than 1W=1C.
E
C
b)
If Dw shifted up by one-third or the demand of Wheat increases, the demand of Cloth
decreases.
The equilibrium- relative commodity price of cloth is 3/4,
Pc/Pw =3/4 or 4C = 3W.
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9
Pc/Pw
Sc (US, UK)
3/2
1
3/4
1/2
Dc(US,UK)
Dc’
120
240
C
11)
UK is small country,
Pw/Pc Pw/Pc
UK is small country.
Sw (US, UK)
2
2/3
Dw(US,UK)
180
240
W
120
With Complete specialization under constant opp. Cost, the equilibrium relative price occurs
between the pre-trade relative commodity price in each nation. Only exception to complete
specialization under constant opp. cost is small country case.
In small country case, trade occur at the pre-trade relative price of US (large nation), Namely,
trade occurs at Pw/Pc = 2/3. And US would not specialize completely in W production. In this
case, The US, W production is 120 after trade and relative commodity price or terms of trade
is 2/3 or 20 C= 30W. The demand intersect supply in horizontal part
UK or Small country would specialize completely in C production and can Exchange 20 C for
30 w. Us pre-trade commodity relative price is 2/3.
So UK receives all of gains. (importance of being unimportant)
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10
Chapter 3) (p.73)
5)
Px/Py
Sx
1 1/2
C
D
F
1
1/2
A
B Dx
1/4
40
60
70
120
x
Sx = Nation 1 ‘ s supply of export of commodity X,
Dx = Nation 2 ‘s Demand for Nation 1’s exports of Commodity X
a)
When Px/Py is 1,
The Nation 1 ‘ s supply of export of commodity X is 60, and Nation 2 ‘s Demand for
Nation 1’s exports of Commodity X is 60 .
So Px/Py =1 is equilibrium relative price. Because Nation 1 ‘ s supply and Nation 2 ‘s
Demand are equal at this price. (F)
b)
THe Nation 1 ‘ s supply of export of commodity X is zero in Px/Py =1/4,
When Px/Py is ½,
The Nation 1 ‘ s supply of export of commodity X is 40, and Nation 2 ‘s Demand for
Nation 1’s exports of Commodity X is 120,
120- 40 (AB) = 80 , excess Demand and The price of Px and Px/Py increases because of
excess demand.
c)
When Px/Py is 1 ½,
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11
The Nation 1 ‘ s supply of export of commodity X is 70, and Nation 2 ‘s Demand for
Nation 1’s exports of Commodity X is 40,
70-40 = 30(CD) , excess Supply and The price of Px and Px/Py decreases because of excess
supply.
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