Econ 1110-1 (Prof. Burkauser)

Dis 214/215 (TA : Donghwee Kwon)

3th section (11 Sep)

* Main Topics: 1) All about PPF 2) Motivation for International Trade (Comparative Advantage)

1. Consider an economy producing only bread and clothing. Bread is produced with land and labor as inputs, while clothing is produced with capital and labor as inputs.

a) Draw the PPF assuming the usual “bowed-out” shape, putting bread in the horizontal axis and clothing on the vertical axis.

b) Draw the possible consequences of the following on the economy’s PPF. Assume each event below occurs separately (and not in combination with other events noted), and use a separate diagram for each answer.

i. A new technology appears in the clothing industry making it possible to use less of each input to make the same amount of output.

ii. The economy wide labor force shrinks over the next year due to vigorous enforcement immigration policy.

iii. PPF being a straight line implies constant returns to scale. (True/False)

2. Harry and Pipa are the only two producers who will make commemorative 2012 London Olympic hats and T-shirts for this summer. Harry works 60 hours in a week and Harry can produce a maximum of 30 T-shirts or 150 hats, or any combination along a straight line PPF between the two in his week of work. Pipa works 40 hours in a week and Pipa can produce a maximum of 40 T-shirts or 360 hats, or any combination along a straight line PPF between the two in her week of work.

Hours Required for One Unit of Output
Person / T-Shirts / Hats
Harry / ______hours / ______hours
Pipa / ______hours / ______hours

a)  Fill in the missing numbers in the table.

b)  Putting HATS ON THE VERTICAL and T-SHIRTS ON THE HORIZONTAL graph Harry’s and Pipa’s individual production possibility frontiers.

c)  Who has the absolute advantage in the production of hats?

d)  Who has the comparative advantage in T-shirt production?

e)  Assume that Elizabeth is telling Harry and Pipa what to do. She has not taken Econ 1110, and hence does not know the wonders of comparative advantage and efficient production. Suppose she has Pipa making 10 T-shirts and 270 hats. Suppose she has Harry spending half his time doing hats and half his time doing T-shirts. In total, how many hats and T-shirts are being made? Indicate where Harry and Pipa are operating on your graphs for part (b).

f)  You are hired by Elizabeth to advise her on efficient production. Putting HATS ON THE VERTICAL and T-SHIRTS ON THE HORIZONTAL, illustrate the efficient combined production possibility frontier when Pipa and Harry are efficiently allocated to the production of hats and T-shirts. On this graph, show exactly where Elizabeth’s original production point is and briefly explain to Elizabeth (and me) how she can get from her production point to a production point with strictly more hats and T-shirts produced.

3. Two countries, Inland and Outland, produce artichokes (A) and bathing suits (B). Inland can produce either 200 artichokes and no bathing suits or 100 bathing suits and no artichokes or any linear combination of the two, and Outland can produce 150 artichokes or 150 bathing suits or any linear combination of the two.

a)  On separate graphs draw the production possibilities frontiers for Inland and Outland.

b)  What is Inland's marginal opportunity cost of producing artichokes? Of producing bathing suits? What is Outland's marginal opportunity cost of producing artichokes? Of producing bathing suits?

Suppose that representatives of Inland and Outland meet and decide that each could gain from trade with the other. They sign a trade agreement stating that the country with the lower cost of producing artichokes will specialize in artichoke production and produce only artichokes, whereas the country with the lower cost of producing bathing suits will specialize in bathing suit production and produce only bathing suits. Each will trade the good that it produces to the other for some quantity of the good that it does not produce. (Note that Inland and Outland engage in barter; no money is necessary.)

c)  Each country is said to have a comparative advantage in specializing in the good that it produces more cheaply. Which country will produce artichokes and which country will produce bathing suits? Why?

d)  What is the maximum price that Inland would be willing to pay for the good that it does not produce and still be willing to participate in trade? Explain. What is the maximum price that Outland would be willing to pay for the good that it does not produce? Explain.

e)  Suppose that Inland and Outland agree on a price of 1.5As for 1B. If Inland were to sell to Outland all of the good that it specializes in, how much of the other good could it buy? If Outland were to sell to Inland all of the good that it specializes in, how much of the other good could it buy? On the graphs from part (a) above, use this information to draw new production possibilities frontiers for Inland and Outland. Assume trade occurs at the price of 1.5 As for 1B.

4. (If time permits)

Abe, Betty and Charlie are the only producers/consumers in a small economy. Abe, Betty and Charlie produce and consume only two things: yaks and xylophones. Given 60 hours of work in a week, Abe can produce a maximum of 3 yaks or 15 xylophones, or any combination along a straight line PPF between the two. With 60 hours of work in a week Betty can produce a maximum of 5 yaks or 20 xylophones, or any combination along a straight line PPF between the two. With 60 hours of work in a week Charlie can produce a maximum of 4 yaks or 8 xylophones, or any combination along a straight line PPF between the two. Assume all three will work exactly 60 hours in total each week.

a) Fill in the missing numbers in the table below:

Hours Required
for one unit of output
Person / yak / xylophone
Abe / 20 hrs. / 4 hrs.
Betty
Charlie

b) Who has the comparative advantage in yak production? Who has the comparative advantage in xylophone production? Who has the absolute advantage in yak production? In xylophone production?

c) Draw each individual’s production possibilities frontier (hint: each individual’s PPF will be a straight line).

d) Assume that all don’t know the wonders of trade (i.e. they insist on self-producing everything they consume). If Abe wants to consume 2 yaks, how many xylophones, at most, can Abe have per week? If Betty wants to consume 16 xylophones, how many yaks, at most, can she consume per week? If Charlie wants to consume 4 yaks, how many xylophones, at most, can he consume per week?

e) Suppose that Abe and Betty decide to trade, but that Charlie is still self-sufficient. If Abe still wants 2 yaks a week and Betty still wants 16 xylophones a week, will they benefit from specialization? How many more yaks (per week) will they have than they had when they were both producing separately? How many more xylophones (per week) will they have now?

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