ECO202 wk2quiz PDF

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ECO-202 QUIZ WK 2

1. Specialization and production possibilities

Suppose Sweden produces only cars and trucks. The resources that are used in the production of these two goods are not specialized—that is, the same set of resources is equally useful in producing both trucks and cars. The shape of Sweden's production possibilities frontier (PPF) should reflect the fact that as Sweden produces more trucks and fewer cars, the opportunity cost of producing each additional truck

remains constant

.

Points: 1/1 Close Explanation Explanation: Recall that the same set of resources is equally useful in producing both trucks and cars. This means that if Sweden decides to produce more cars and fewer trucks, the resources that it uses to produce the additional cars will be as well suited to the production of cars as the resources already being used in car production. Therefore, the opportunity cost of producing each additional car remains constant as more cars are produced. The following graphs show two possible PPFs for Sweden's economy: a straight-line PPF ( PPF1PPF1) and a bowed-out PPF (PPF2PPF2). Graph 1CARSTRUCKSPPF1 Graph 2CARSTRUCKSPPF2 Based on the previous description, the trade-off Sweden faces between producing trucks and cars is Graph 1 . best represented by

Points: 1/1 Close Explanation Explanation:

For bowed-out PPFs, the opportunity cost of producing cars is reflected in the curvature of the PPF. In flatter regions, producing an additional truck requires giving up fewer cars. However, in steeper regions, producing an additional truck requires giving up more cars. In other words, the opportunity cost of producing trucks changes as you move along the PPF. For linear PPFs, the opportunity cost of producing trucks is constant and reflected in the slope of the PPF. If the PPF is flatter, producing an additional truck requires giving up fewer cars. If the PPF is steeper, producing an additional truck requires giving up more cars. In this case, because the opportunity cost of producing additional trucks remains constant as more resources are shifted to the production of trucks, the PPF must be linear. Therefore, Graph 1 best represents the trade-off Sweden faces between producing trucks and cars.

2. Comparative and absolute advantage

Eric and Ginny are farmers. Each one owns a 20-acre plot of land. The following table shows the amount of corn and rye each farmer can produce per year on a given acre. Each farmer chooses whether to devote all acres to producing corn or rye or to produce corn on some of the land and rye on the rest.

Corn (Bushels per acre)

Rye (Bushels per acre)

Eric

30

10

Ginny

28

7

On the following graph, use the blue line (circle symbol) to plot Eric's production possibilities frontier (PPF), and use the purple line (diamond symbol) to plot Ginny's PPF. Your AnswerEric's PPFGinny's PPF01002003004005006007008009001000200180160140120100806040200RYE (Bushels)CORN (Bushels)560, 0Y-Intercept: 200X-Intercept: 600Slope: -0.33 Correct Answer Points: 1/1 Close Explanation Explanation:

You can see that when Eric devotes all 20 acres to producing corn, he can produce 600 bushels of corn per year (20

acres×30 bushels per acre20 acres×30 bushels per acre). On the other hand,

when he uses all 20 acres to produce rye, he produces 200 bushels of rye per year (20

acres×10 bushels per acre20 acres×10 bushels per acre). Therefore, his PPF extends from

(600, 0) to (0, 200). You can do similar calculations for Ginny to show that when she devotes all of her land to producing corn, she can produce 560 bushels of corn per year. On the other hand, when she uses all 20 acres to produce rye, she produces 140 bushels of rye per year. Therefore, her PPF extends from (560, 0) to (0, 140). Notice that both PPFs are linear rather than bowed outward because there is a constant trade-off between the two goods. Eric

has an absolute advantage in the production of corn, and

Eric

has an absolute

advantage in the production of rye. Points: 1/1 Close Explanation Explanation: An individual has an absolute advantage in the production of a good if he or she can produce a unit of output using fewer resources than someone else. Here, the only resource you should consider is land. Eric can produce 30 bushels of corn per acre of land, while Ginny can produce 28 bushels of corn per acre of land. Therefore, Eric has an absolute advantage in the production of corn. Similarly, Eric can produce 10 bushels of rye per acre of land, while Ginny can produce 7 bushels of rye per acre of land. Therefore, Eric has an absolute advantage in the production of rye. Since Eric and Ginny own the same resources (in this case, the size of both plots of land is the same), another way you can determine who has the absolute advantage in the production of a good is to see who can produce more of that good if both people devote all of their resources to making it. Eric's opportunity cost of producing 1 bushel of rye is

5 3

bushels of corn, whereas Ginny's opportunity cost of producing 1 bushel of rye is

4

bushels of corn. Because Eric has a

Eric

lower

opportunity cost of producing rye than Ginny,

has a comparative advantage in the production of rye, and

Ginny

has a comparative

advantage in the production of corn. Points: 0.6 / 1 Close Explanation Explanation: For each acre Eric uses to produce corn, he produces 30 bushels of corn per year. But using that acre to produce corn means he must forgo the 10 bushels of rye he could have produced on that land. Therefore, Eric's opportunity cost of producing 30 bushels of corn is 10 bushels of rye, so the opportunity cost of producing each bushel of corn is 1/3 bushel of rye per bushel of corn (10 bushels of rye30 bushels of corn10 bushels of rye30 bushels of corn). (Note: The slope of Eric's PPF is -1/3.) You can compute Eric’s opportunity cost of producing a bushel of rye by taking the reciprocal of the opportunity cost of producing a bushel of corn. That is, the opportunity cost of producing a bushel of rye, in this case, is 3 bushels of corn per bushel of rye. By the same logic, Ginny could use an acre of land to produce either 28 bushels of corn or 7 bushels of rye, so her opportunity cost of producing corn is 1/4 bushel of rye per bushel of corn (7 bushels of rye28 bushels of corn7 bushels of rye28 bushels of corn). (Note: The slope of Ginny's PPF is -1/4.) Comparative advantage is determined by the opportunity cost of producing a good rather than the amount of resources used to make that good. An individual has a comparative advantage in producing a good if he or she can produce it at a lower opportunity cost than someone else. In this case, Eric has a lower opportunity cost of producing rye than Ginny, so Eric has a comparative advantage in the production of rye. Note that the opposite is true for corn: Repeating the previous calculations, you can see that Eric's opportunity cost of producing a bushel of corn is 1/3 bushel of rye, and Ginny's opportunity cost of producing a bushel of corn is 1/4 bushel of rye. Therefore, Ginny has a comparative advantage in the production of corn, since she gives up less rye to produce corn. Notice that, although it is possible for one person to have an absolute advantage in the production of both goods, it is impossible for one person to have a comparative advantage in the production of both goods. Since Eric has a lower opportunity cost of producing rye than Ginny has, it must be the case that Ginny has a lower opportunity cost of producing corn than Eric has. On the other hand, if both

individuals have the same opportunity cost of producing both goods, neither has a comparative advantage in the production of either good. 3. Gains from trade

Consider two neighboring island countries called Contente and Felicidad. They each have 4 million labor hours available per month that they can use to produce jeans, rye, or a combination of both. The following table shows the amount of jeans or rye that can be produced using 1 hour of labor.

Jeans (Pairs per hour of labor)

Country

Rye (Bushels per hour of labor)

Contente

6

12

Felicidad

4

16

Initially, suppose Contente uses 1 million hours of labor per month to produce jeans and 3 million hours per month to produce rye, while Felicidad uses 3 million hours of labor per month to produce jeans and 1 million hours per month to produce rye. Consequently, Contente produces 6 million pairs of jeans and 36 million bushels of rye, and Felicidad produces 12 million pairs of jeans and 16 million bushels of rye. Assume there are no other countries willing to trade goods, so, in the absence of trade between these two countries, each country consumes the amount of jeans and rye it produces. Contente's opportunity cost of producing 1 pair of jeans is

opportunity cost of producing 1 pair of jeans is

4 bushels

has a comparative advantage in the production of jeans, and

2 bushels

of rye, and Felicidad's

of rye. Therefore,

Felicidad

Contente

has a comparative

advantage in the production of rye. Points: 1/1 Close Explanation Explanation: Using an hour of labor, Contente can produce 6 pairs of jeans or 12 bushels of rye. Therefore, the opportunity cost of a pair of jeans is 2 bushels per pair (12 bushels6 pairs12 bushels6 pairs). Using an hour of labor, Felicidad can produce 4 pairs of jeans or 16 bushels of rye. Therefore, the opportunity cost of a pair of jeans is 4 bushels per pair (16 bushels4 pairs16 bushels4 pairs). Since Contente gives up fewer bushels per pair of jeans, it has a comparative advantage in the production of jeans.

You can compute Contente's opportunity cost of a bushel of rye by taking the reciprocal of the opportunity cost of a pair of jeans. That is, the opportunity cost of a bushel of rye, in this case, is 1/2 pair per bushel. Similarly, Felicidad's opportunity cost of a bushel of rye is equal to 1/4 pair per bushel. Since Felicidad gives up fewer pairs of jeans per bushel of rye, it has a comparative advantage in the production of rye. Suppose that each country completely specializes in the production of the good in which it has a comparative advantage, producing only that good. In this case, the country that produces jeans will produce

24

million pairs per month, and the country that produces rye will produce

64

million bushels per month. Points: 1/1 In the following table, enter each country's production decision on the third row of the table (marked “Production”). Close Explanation Explanation: Recall that Contente has a comparative advantage in the production of jeans and that Felicidad has a comparative advantage in the production of rye. If Contente completely specializes in the production of jeans, it produces 24 million pairs of jeans (4

million hours×6 pairs of jeans per hour4 million hours×6 pairs of jeans per hour).

Similarly, if Felicidad completely specializes in the production of rye, it produces 64 million bushels of rye (4

million hours×16 bushels of rye per hour4 million hours×16 bushels of rye per hour).

Suppose the country that produces jeans trades 14 million pairs of jeans to the other country in exchange for 42 million bushels of rye. In the following table, select the amount of each good that each country exports and imports in the boxes across the row marked “Trade Action,” and enter each country's final consumption of each good on the line marked “Consumption.” Close Explanation

Explanation: When they specialize, Contente produces 24 million pairs of jeans per month, and Felicidad produces 64 million bushels of rye per month. If Contente trades 14 million pairs of jeans for 42 million bushels of rye from Felicidad, Contente will consume 10 million pairs of jeans and 42 million bushels of rye, and Felicidad will consume 14 million pairs of jeans and 22 million bushels of rye. Note that when a country imports goods, it brings them into the country. In this case, the consumption of that good must be larger than what the country produces itself. Similarly, when a country exports goods, it sends them out of the country. In this case, the consumption of that good must be smaller than what the country produces itself. When the two countries did not specialize, the total production of jeans was 18 million pairs per month, and the total production of rye was 52 million bushels per month. Because of specialization, the total production of jeans has increased by

6

million pairs per month, and the total production of rye has increased by

12

million bushels per month. Points: 1/1 Because the two countries produce more jeans and more rye under specialization, each country is able to gain from trade. Calculate the gains from trade—that is, the amount by which each country has increased its consumption of each good relative to the first row of the table. In the following table, enter this difference in the boxes across the last row (marked “Increase in Consumption”). Close Explanation Explanation: Initially, before the two countries specialized, Contente produced (and consumed) 6 million pairs of jeans and 36 million bushels of rye per month, and Felicidad produced (and consumed) 12 million pairs of jeans and 16 million bushels of rye per month. When they specialized, Contente produced 24 million pairs of jeans per month, and Felicidad produced 64 million bushels of rye per month. This is an increase of 6 million pairs of jeans and 12 million bushels of rye per month. If Contente trades 14 million pairs of jeans for 42 million bushels of rye

from Felicidad, both countries will end up consuming more of both goods. In particular, there will be an increase of 4 million pairs of jeans and 6 million bushels of rye for Contente and an increase of 2 million pairs of jeans and 6 million bushels of rye for Felicidad.

Contente Jeans Rye (Millions of (Millions of pairs) bushels)

Felicidad Jeans Rye (Millions of (Millions of pairs) bushels)

Without Trade Production

6

36

12

16

Consumpti

6

36

12

16

24

0

0

84

on With Trade Production

Exports

Trade

Imports

Imports

Exports

action Consumpti

14

42

14

42

10

42

14

22

6

2

6

on Gains from Trade Increase in

4

Consumpti on Points: 1/1 Close Explanation Explanation: You can also see how each country gains from trade by using a production possibilities frontier (PPF) diagram. The blue lines on the following diagrams show the PPFs of Contente and Felicidad. The black points (plus symbol) show their initial consumption of jeans and rye. The orange points (square symbol) show the amount of jeans and rye each consumes after specialization and trade. Contente010203040506070804035302520151050JEANS (Millions of pairs)RYE (Millions of bushels)Contente's PPFBeforeAfter

Felicidad010203040506070804035302520151050JEANS (Millions of pairs)RYE (Millions of bushels)Felicidad's PPFBeforeAfter Note that the total gains from trade are 6 million pairs of jeans and 12 million bushels of rye per month, which is the total increase in production you calculated earlier. Visually, you can see that there are gains from trade, because countries are able to consume at points that were previously not feasible (that is, points outside of their PPF).

4. Specialization and trade

When a country has a comparative advantage in the production of a good, it means that it can produce this good at a lower opportunity cost than its trading partner. Then the country will specialize in the production of this good and trade it for other goods. The following graphs show the production possibilities frontiers (PPFs) for Freedonia and Lamponia. Both countries produce grain and tea, each initially (i.e., before specialization and trade) producing 18 million pounds of grain and 9 million pounds of tea, as indicated by the grey stars marked with the letter A. Freedonia06121824303642484842363024181260TEA (Millions of pounds)GRAIN (Millions of pounds)PPFA Lamponia06121824303642484842363024181260TEA (Millions of pounds)GRAIN (Millions of pounds)PPFA Freedonia has a comparative advantage in the production of

comparative advantage in the production of

grain

tea

, while Lamponia has a

. Suppose that Freedonia and Lamponia

specialize in the production of the goods in which each has a comparative advantage. After specialization, the two countries can produce a total of

36

million pounds of tea and

36

million pounds of grain. Points:

1/1 Close Explanation Explanation: The opportunity cost of a pound of grain in Freedonia is 3/2 pounds of tea, whereas the opportunity cost of a pound of grain in Lamponia is 1/2 pound of tea. Therefore, Lamponia has a comparative advantage in the production of grain. (Note: One way to find the opportunity cost of a pound of grain in Freedonia is to examine how many pounds of grain Freedonia can produce if it produces only that good and then determine how many pounds of tea it gives up: 36 million pounds of tea24 million pounds of grain=3/2

pounds of tea per pound of grain36 mi

llion pounds of tea24 million pounds of grain=3/2 pounds of tea per pound of grain.) The opportunity cost of a pound of tea in Freedonia is 2/3 pound of grain, whereas the opportunity cost of a pound of tea in Lamponia is 2 pounds of grain. Therefore, Freedonia has a comparative advantage in the production of tea. When the two countries specialize, Freedonia will produce 36 million pounds of tea, and Lamponia will produce 36 million pounds of grain because Freedonia has a comparative advantage in producing tea and Lamponia has a comparative advantage in producing grain. Suppose that Freedonia and Lamponia agree to trade. Each country focuses its resources on producing only the good in which it has a comparative advantage. The countries decide to exchange 12 million pounds of grain for 12 million pounds of tea. This ratio of goods is known as the price of trade between Freedonia and Lamponia. The following graph shows the same PPF for Freedonia as before, as well as its initial consumption at point A. Place a black point (plus symbol) on the graph to indicate Freedonia's consumption after trade. Note: Dashed drop lines will automatically extend to both axes. Your AnswerFreedoniaConsumption After Trade06121824303642484842363024181260TEA (Millions of pounds)GRAIN (Millions of pounds)PPFA12, 24 Correct Answer Points: 1/1 Close Explanation Explanation:

Because Freedonia has a comparative advantage in the production of tea, Freedonia will produce 36 million pounds of tea and 0 pounds of grain. Freedonia exports 12 million pounds of tea for 12 million pounds of grain. So, after trade, Freedonia consumes 12 million pounds of grain as well as 24 million pounds of tea. The following graph shows the same PPF for Lamponia as before, as well as its initial consumption at point A. As you did for Freedonia, place a black point (plus symbol) on the following graph to indicate Lamponia's consumption...