ECON 102 Tutorial: Week 11
Ayesha Ali
www.lancaster.ac.uk/postgrad/alia10/econ102.html
a.ali11@lancaster.ac.uk
office hours: 8:00AM – 8:50AM tuesdays LUMS C85
Question 1
The table below shows the production possibilities for two products, pens and pencils.
Point
Pens
Pencils
A
10
0
B
5
10
C
2
25
a) Calculate the opportunity cost of producing 1 additional pen between points A and B.
b) Calculate the opportunity cost of producing 1 additional pencil between points A and B.
c) Calculate the opportunity cost of producing 1 additional pen between points B and C.
d) Calculate the opportunity cost of producing 1 additional pencil between points B and C.
In general, the equation to calculate opportunity cost is:
𝑆𝑎𝑐𝑟𝑖𝑓𝑖𝑐𝑒 𝑜𝑓 𝑔𝑜𝑜𝑑 𝑥
𝑂𝑝𝑝𝑜𝑟𝑡𝑢𝑛𝑖𝑡𝑦 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑 𝑦 = 𝐺𝑎𝑖𝑛 𝑖𝑛 𝑔𝑜𝑜𝑑 𝑦
Question 1(a)
The table below shows the production possibilities for two products, pens and pencils.
Point
Pens
Pencils
A
10
0
B
5
10
C
2
25
Calculate the opportunity cost of producing 1 additional pen between points A and B.
The opportunity cost of pens between A and B is one pen for two pencils.
OP = (10-0)/(10-5) = 2
In general, the equation to calculate opportunity cost is:
𝑆𝑎𝑐𝑟𝑖𝑓𝑖𝑐𝑒 𝑜𝑓 𝑔𝑜𝑜𝑑 𝑥
𝑂𝑝𝑝𝑜𝑟𝑡𝑢𝑛𝑖𝑡𝑦 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑 𝑦 = 𝐺𝑎𝑖𝑛 𝑖𝑛 𝑔𝑜𝑜𝑑 𝑦
Question 1(b)
The table below shows the production possibilities for two products, pens and pencils.
Point
Pens
Pencils
A
10
0
B
5
10
C
2
25
Calculate the opportunity cost of producing 1 additional pencil between points A and B.
The opportunity cost of pencils between A and B is one pencil for half a pen.
OP = (10-5)/(10-0) = ½
Question 1(c)
The table below shows the production possibilities for two product, pens and pencils.
Point
Pens
Pencils
A
10
0
B
5
10
C
2
25
Calculate the opportunity cost of producing 1 additional pen between points B and C. What
conclusions can you come to about this opportunity cost compared to the calculation you
made in part(a)?
The opportunity cost of pens between B and C is one pen for five pencils.
OP = (25-10)/(5-2)) = 5
This is a much higher opportunity cost than between A and B.
Question 1(d)
The table below shows the production possibilities for two products, pens and pencils.
Point
Pens
Pencils
A
10
0
B
5
10
C
2
25
Calculate the opportunity cost of producing 1 additional pencil between points B and C. What
conclusions can you come to about this opportunity cost compared to the calculation you
made in part (b)?
The opportunity cost of pencils between B and C is one pencil for 1/5 of a pen.
OP = (5-2)/(25-10) = 1/5
This is a much lower opportunity cost than between A and B.
Question 2(a)
Swedish and Danish workers can each produce 4 cars a year. A Swedish worker can produce
10 tonnes of grain a year, whereas a Danish worker can produce 5 tonnes of grain a year.
Assume that each country has 100 million workers.
Construct a table showing the production opportunities of both countries.
First thing to do is use the information above to find out how many workers are needed to
produce one car and one ton of grain per year:
Number of Workers needed to
make:
One car per year One tonne of
grain per year
Swedish ¼
1/10
Danish
1/5
¼
Question 2(a) ctd.
In the prev. slide, we found how many workers are needed to produce one unit of each good.
Now we want to show how much each country will produce in a year.
We assume each country has 100 million workers. So, we divide the total number of workers
by the number of workers needed to produce one unit of each good per year:
Number of Workers needed to
make:
One car per year One tonne of
grain per year
Amount produced in a year by
100 million workers
Cars
Tonnes of grain
Swedish ¼
1/10
400 million
1,000 million
Danish
1/5
400 million
500 million
¼
Note: You might not always have a problem that looks at amount produced by a certain
number of workers. See Slide 14 in Week 10 Lecture Slides for an example that looks at the
amount produced in a certain amount of time.
Question 2(b)
Graph the production possibilities frontier of the Swedish and Danish economies.
Amount produced in a year by
100 million workers
Cars
Tonnes of grain
So, here is what we will be graphing:
I’ve put cars on the Y-axis and
grain on the X-axis:
Cars
Swedish
Danish
400 million
400 million
1,000 million
500 million
Y-axis: With 100 million workers and four cars per
worker, if either economy were devoted
completely to cars, it could make 400 million cars.
400
Swedish
Danish
500
Grain
1000
X-axis: Since a Swedish worker can produce 10
tonnes of grain, if Sweden produced only grain it
would produce 1,000 million tonnes. Since a
Danish worker can produce 5 tonnes of grain, if
Denmark produced only grain it would produce
500 million tonnes.
Note: Because the trade-off between cars and
grain is constant, the production possibilities
frontier is a straight line.
Question 2(c)
For Sweden, what is the opportunity cost of a car? Of grain? For Denmark, what is the
opportunity cost of a car? Of grain? Put this information in a table.
Amount produced in a year by
100 million workers
Cars
Tonnes of grain
We’ll use the information that we found in part (b):
Swedish
400 million
1,000 million
Danish
400 million
500 million
And we’ll use our equation for Opportunity Cost:
𝑆𝑎𝑐𝑟𝑖𝑓𝑖𝑐𝑒 𝑜𝑓 𝑔𝑜𝑜𝑑 𝑥
𝑂𝑝𝑝𝑜𝑟𝑡𝑢𝑛𝑖𝑡𝑦 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑 𝑦 = 𝐺𝑎𝑖𝑛 𝑖𝑛 𝑔𝑜𝑜𝑑 𝑦
Opportunity cost of
Sweden
1 car
(in terms of grain given up)
2.5
Denmark 1.25
1 tonne of grain
(in terms of cars given up)
0.4
0.8
Question 2(d)
Which country has an absolute advantage in producing cars? In producing grain?
First, let’s define Absolute advantage:
Someone has absolute advantage if they can produce more output than others, using the
same amount of inputs. Or, we could say that they produce the same output as others,
using fewer inputs.
So, what we want to compare
is the output per worker
between the two countries:
Swedish
Amount produced in a year
by 100 million workers
Cars
Tonnes of grain
400 million 1,000 million
Danish
400 million
500 million
Neither country has an absolute advantage in producing cars, because they are equally
productive (same output per worker).
Sweden has an absolute advantage in producing grain, because it is more productive (greater
output per worker).
Question 2(e)
Which country has a comparative advantage in producing cars? In producing grain?
First, let’s define Comparative advantage:
One person has a comparative advantage over another in a task if his or her opportunity
cost of performing a task is lower than the other person’s opportunity cost.
Opportunity cost of
So, we’ll use the opportunity
cost that we found in part (c):
Sweden
1 car
(in terms of grain given up)
2.5
Denmark 1.25
1 tonne of grain
(in terms of cars given up)
0.4
0.8
Denmark has a comparative advantage in producing cars, because it has a lower opportunity
cost in terms of grain given up.
Sweden has a comparative advantage in producing grain, because it has a lower opportunity
cost in terms of cars given up.
Question 2(f)
Without trade, half of each country’s workers produce cars and half produce grain. What
quantities of cars and grain does each country produce?
So, 50 million workers will produce cars and the other 50 million will produce grain in each
country.
Number of Workers
needed to make:
We know that:
Amount produced in
a year by 1 worker
One car
per year
One tonne of
grain per year
Cars
Tonnes of
grain
Swedish
¼
1/10
4
10 tonnes
Danish
¼
1/5
4
5 tonnes
Sweden would produce 200 million cars (50 million workers times 4 cars each), and 500
million tonnes of grain (50 million workers times 10 tonnes each).
Denmark would produce 200 million cars (50 million workers times 4 cars each) and 250
million tonnes of grain (50 million workers times 5 tonnes each).
Question 2(g)
Starting from a position without trade, give an example in which trade makes each country
better off.
From any situation with no trade, in which each country is producing some cars and some
grain, suppose Sweden changed 1 worker from producing cars to producing grain. That worker
would produce 4 fewer cars and 10 additional tonnes of grain.
Then suppose Sweden offers to trade 7 tonnes of grain to Denmark for 4 cars.
Sweden will do this because it values 4 cars at 10 tonnes of grain, so it will be better off if the
trade goes through.
Suppose Denmark changes 1 worker from producing grain to producing cars. That worker
would produce 4 more cars and 5 fewer tonnes of grain.
Denmark will take the trade because it values 4 cars at 5 tonnes of grain, so it will be better
off.
With the trade and the change of 1 worker in both Sweden and Denmark, each country gets
the same amount of cars as before, and both get additional tonnes of grain (3 for Sweden and
2 for Denmark).
Thus by trading and changing their production, both countries are better off.
Question 3(a)
Morgan and Oliver share a flat. Their favourite activities are cooking pizza and making
homebrew beer. Oliver takes 4 hours to produce 1 barrel of beer, and 2 hours to make a pizza.
Morgan takes 6 hours to produce 1 barrel of beer, and 4 hours to make a pizza.
What is each flatmate’s opportunity cost of making a pizza?
Oliver’s opportunity cost of making a pizza = ½ barrel of beer
because he could brew ½ barrel in the time (2 hours) it takes him to make a pizza.
Morgan’s opportunity cost of making a pizza = 2/3 barrels of beer
because she could brew 2/3 of a barrel in the time (4 hours) it takes her to make a pizza.
Who has the absolute advantage in making pizza?
Oliver has an absolute advantage in making pizza since he can make one in two hours, while it
takes Morgan four hours.
(In other words, he uses fewer inputs (time, in this case) than Morgan to produce the same
amount of output as Morgan)
Who has the comparative advantage in making pizza?
Oliver has a comparative advantage in making pizza because Oliver’s opportunity cost of
making pizza is less than Morgan’s.
Question 3(b)
If Oliver and Morgan trade foods with each other, who will trade away pizza in exchange for
beer?
Since Oliver has a comparative advantage in making pizza, he will make pizza and exchange it
for beer that Morgan makes.
Note: This is an example of the principle of comparative advantage. It states that under free
trade, the individual will produce more of and consume less of a good for which he has a
comparative advantage.
Question 3(c)
The price of pizza can be expressed in terms of barrels of beer. What is the highest price at
which pizza can be traded that would make both flatmates better off? What is the lowest
price? Explain.
The highest price of pizza in terms of beer that will make both flat-mates better off is 2/3 of a
barrel of beer. If the price were higher than that, then Morgan would prefer making her own
pizza (at an opportunity cost of 2/3 of a barrel of beer), rather than trading for pizza that
Oliver makes.
The lowest price of pizza in terms of beer that will make both flat-makes better off is ½ of a
barrel of beer. If the price were lower than that, then Oliver would prefer making his own
beer (he can make ½ a barrel of beer instead of making a pizza) rather than trading for beer
that Morgan makes.
In short:
The highest price of pizza where both will be better off = the buyer’s opportunity cost of pizza
The lowest price of pizza where both will be better off = the seller’s opportunity cost of pizza
So, the feasible price range lies between the opportunity cost of the two flat-mates.
Question 4(a)
Consider a small country that imports bananas at the price of £20 per bag. The demand curve
is D = 500 – 5P. The supply curve is S = -50 + 5P.
Determine the no-trade equilibrium. What is consumer surplus and producer surplus?
For the no-trade equilibrium, we set demand equal to supply:
500 − 5𝑃 = −50 + 5𝑃
Solving, we find 𝑃 = 55.
We can then substitute into demand (or supply) to get Q 𝑄 = 500 − 5 55 = 225.
If we graph our Supply and Demand curves, we should get:
To find consumer and produce surplus:
1
𝐶𝑆 = 100 − 55 225
2
𝐶𝑆 = 5062.50
1
𝑃𝑆 = 2 55 − 10 225
𝑃𝑆 = 5062.50
Question 4(b)
Determine the free trade equilibrium. What is consumer surplus and producer surplus?
If we impose the free trade price of £20, we can substitute that into the demand curve to get
𝐷 = 400, and substituting into the supply curve gives 𝑆 = 50.
Graphically, we have:
1
So consumer surplus is 𝐶𝑆 = 2 100 − 20 400 = 16,000,
1
and producer surplus is 𝑃𝑆 = 20 − 10 50 = 250.
2
Note there are gains from trade: with trade, 𝑃𝑆 + 𝐶𝑆 = 16,250, which compares with the no
trade scenario in part (a) 𝑃𝑆 + 𝐶𝑆 = 10,125.
Question 4(c)
Suppose the country now imposes an import tariff of £10 per bag of bananas. Draw the
diagram for this policy. Solve for equilibrium prices and quantities of the equilibrium with the
tariff. Calculate the effects on consumer surplus, producer surplus, government revenue, and
the net welfare effect of the tariff.
Imposing an import tariff of £10 per bag raises the world price to £30.
Question 4(c)
Imposing an import tariff of £10 per bag raises the world price to £30.
We can substitute this into the demand and supply curves curve to get 𝐷 = 350 and 𝑆 = 100.
Graphically, we would have:
1
Now, consumer surplus is 𝐶𝑆 = 2 100 − 30 350 = 12250,
1
And producer surplus is 𝑃𝑆 = 2 30 − 10 100 = 1000.
Tariff revenue is 𝑇𝑅 = 10 × 350 − 100 = 2,500.
Hence the net welfare effect of the tariff (compared to free trade) is
Δ𝐶𝑆 + Δ𝑃𝑆 + 𝑇𝑅 = 12,250 − 16,000 + 1,000 − 250 + 2,500 = −500
That is, there is a net welfare loss of imposing the import tariff. However, producers win while
consumers lose.
Question 4(d)
Suppose now that (without the tariff) the country imposes a quota that limits imports to 50
bags. Solve for equilibrium prices and quantities of the equilibrium with the quota. Calculate
the effects on consumer surplus, producer surplus, and the quota rent.
Now, if instead of a tariff, an import quota is imposed instead, what this does is to shift the
supply curve to the right (this now becomes a supply curve which combines both domestic
and imported goods).
Question 4(d)
Mathematically, the supply curve is now: 𝑆 = −50 + 5𝑃 + 50 = 5𝑃.
So, setting this new supply curve with the quota equal to demand gives:
5𝑃 = 500 − 5𝑃
So now 𝑃 = 50,
And substituting into the demand curve (or the new supply curve) gives 𝑄 = 250.
This is the total quantity demanded, of which 50 units is imported, so domestic supply is 200.
From here we can find consumer and produce surplus:
1
𝐶𝑆 = 100 − 50 250 = 6250
2
1
𝑃𝑆 = 50 − 10 200 = 4000
2
So the change in consumer surplus is Δ𝐶𝑆 = 6250 − 16000 = −9750,
And the change in producer surplus is Δ𝑃𝑆 = 4000 − 250 = 3750.
The quota rent is 250 − 200 50 − 20 = 1,500.
Next Class
 Week 12 Worksheet
 Review the Specimen Exam on Moodle

Send me your questions before Monday, and I will try to go
over them in next week’s tutorial.
 Short-Answer Exam is Next Friday!