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George Washington University *

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1011

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Economics

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Apr 3, 2024

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ECON 1011 Prof. Foster ©I. R. Foster 1 OPPORTUNITY COST AND TRADE AK Terms: Production Possibilities Frontier – curve showing the maximum possible combinations of two products that can be produced with available resources and current technology . Productivity – the amount of output produced with given one unit of an input Production Function – equation that calculates the total amount of output that can be produced given productivity and a certain level of input Absolute Advantage – the ability of an individual, firm or country to produce more of a good or service than competitors using the same resources . Comparative Advantage – the ability of an individual, firm or country to produce a good or service at a lower opportunity cost than competitors . Autarky – a situation of no trade between countries Specialization – production of the good or service in which an individual, firm or country has a comparative advantage Terms of Trade - the rate of exchange of one good or service for another when two countries trade with each other. True/False: 1) Comparative advantage means the ability to produce a good or service at a lower opportunity cost than any other producer. True or False? 2) Specializing in the production of a good or service in which one has a comparative advantage enables a country to produce a combination of goods that lies outside its own production possibilities frontier. True or False? 3) Individuals who have never been the best at doing anything cannot have a comparative advantage in producing any product. True or False? 4) If Blake can pick more cherries in one hour than Cody, then Blake has a comparative advantage in cherry picking. True or False? 5) The basis for trade is absolute advantage, not comparative advantage. True or False? 6) If a country produces only two goods, then it is not possible to have a comparative advantage in the production of both those goods. True or False? 7) In a two-good, two country world, if one country has an absolute advantage in the production of both goods, it can still benefit by trading with the other country. True or False? 8) It is not possible to have a comparative advantage in producing a good or service without having an absolute advantage. True or False? Multiple Choice: 9) If you can produce more of something than others with the same resources, you have a comparative/absolute advantage.

ECON 1011 Prof. Foster ©I. R. Foster 2 Problems & Graphing Questions: 1) Only two goods are produced in an economy: tanks and wheat. The table below identifies six possible combinations of tanks and wheat that can be produced given the currently available production technology and resources. All resources are fully utilized. Combination Tanks Produced Per Year Bushels of Wheat Produced Per Year A 0 1,000,000 B 1,000 950,000 C 2,000 850,000 D 3,000 700,000 E 4,000 400,000 F 5,000 0 a) Draw a production possibilities frontier based on the information in the table above. Place tanks on the X axis and wheat on the Y axis. Label the axes and the six points correctly. b) Fill-in-the-blanks and circle the correct answers . The opportunity cost of moving from Point B to Point C is _ 100,000 _________ tanks/bushels of wheat. The opportunity cost of moving from Point D to Point E is __ 300,000 ________ tanks/bushels of wheat . This PPF depicts increasing/constant opportunity cost. Explain your choice. PPF is bowed out – the opportunity cost of producing more of one good gets higher and higher c) Draw a new PPF on the graph to depict what would happen if there was an improvement in the technology for producing tanks. If the economy is originally at point D, would it now be able to produce more of wheat and tanks? Yes No

ECON 1011 Prof. Foster ©I. R. Foster 3 2) Consider the following data for the harvest of crabs versus the harvest of fish off the coast of Virginia: a) Graph the production possibilities frontier given in the table above with fish on the X axis and crabs on the Y axis. Label both axes and each of the combinations. b) If this economy is currently producing 30 crabs and 40 fish, is it possible for it to produce more of both? Yes, since the point is inside the PPF c) Explain how this economy might be able to produce 45 fish and 45 crabs? If there is an increase in resources or an improvement in technology d) Assume this economy could either be at Point B or Point C. From which of these points is it more costly to produce more crabs? Explain your answer. For each additional crab produced at point B, the opportunity cost is 1.33 fish. For each additional crab produced at point C, the opportunity cost is 2 fish. It is more costly to produce additional crabs from point C.

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ECON 1011 Prof. Foster ©I. R. Foster 4 3) Suppose in the United States, the opportunity cost of producing a motor engine is 4 auto bodies. In Canada, the opportunity cost of producing a motor engine is 2 auto bodies. a. What is the opportunity cost of producing an auto body for the United States? ¼ of a motor engine b. What is the opportunity cost of producing an auto body for Canada? ½ of a motor engine c. Which country has a comparative advantage in the production of auto bodies? United States d. Which country has a comparative advantage in the production of motor engines? Canada 4) In Italy, an automobile can be produced by 8 workers in one day, and a washing machine by 3 workers in one day. In the United States, an automobile can be produced by 6 workers in one day, and a washing machine by 2 workers in one day. Assume each country has 48 workers. a) Which country has an absolute advantage in the production of automobiles? US – it takes only 6 workers to produce an automobile in the US than in Italy where it takes 8 workers b) Which country has a comparative advantage in the production of washing machines? The opportunity cost of producing a washing machine in Italy is 0.375 automobiles (can calculate as 3 workers/8 workers, or 6 automobiles/16 automobiles) The opportunity cost of producing a washing machine in the US is 0.33 automobiles (can calculate as 2 workers/6 workers, or 8 automobiles/24 automobiles) Therefore the US has a comparative advantage in the production of washing machines 5) The figure below shows the production possibilities frontier for Vidalia, a nation that produces two goods, roses and orchids. Another way to show this information: Production Possibilities Frontier Country Orchids (dozens) Roses (Dozens) Vidalia 80 200

ECON 1011 Prof. Foster ©I. R. Foster 5 Another way to show this information: Production Possibilities Frontier Possibilities Orchids (dozens) Roses (Dozens) A 0 200 B 20 150 C 40 100 D 60 50 E 80 0 a) What is the opportunity cost of one dozen orchids? Specify units correctly. 2.5 dozen roses b) What is the opportunity cost of one dozen roses? Specify units correctly. 0.4 dozen orchids c) Suppose Vidalia is currently producing 20 dozen orchids per period. How many roses is it also producing, assuming that resources are fully utilized? Calculate this number . To produce 1 dozen orchids, 2.5 dozen roses are given up; so, to produce 20 dozen orchids, 50 dozen roses are given up. That means 200 - 50 = 150 dozen roses are being produced when 20 dozen orchids are also being produced. d) The linear production possibilities frontier indicates that the tradeoff between roses and orchids is constant/increasing . 6) Refer to the information provided in the table below to answer the questions that follow.

ECON 1011 Prof. Foster ©I. R. Foster 6 Another way to show this information: Another way to show this information: Production Possibilities Frontier Oranges (bushels/acre) Bananas (Bushels/acre) MEXICO 200 200 GUATEMALA 50 100 a) In Mexico, the opportunity cost of 1 bushel of bananas is ______ 1 _____ bushel(s) of oranges. b) In Guatemala, the opportunity cost of 1 bushel of oranges is ____ 2 _______ bushel(s) of bananas. c) In Mexico, the opportunity cost of 1 bushel of oranges is _____ 1 ______ bushel(s) of bananas. d) In Guatemala, the opportunity cost of 1 bushel of bananas is ____ 1/2 _______ bushel(s) of oranges. e) The opportunity cost of producing a bushel of oranges in Mexico is higher than/the same as/lower than that in Guatemala. f) Guatemala has a(n) absolute/comparative advantage in banana production. g) Mexico has an absolute advantage and a comparative advantage in orange production. True or False?

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ECON 1011 Prof. Foster ©I. R. Foster 7 h) Guatemala should specialize in and export _ bananas _, and Mexico should specialize in and export _ oranges _. i) Before specialization, Mexico produces 120 bushels of oranges and 80 bushels of bananas, and Guatemala produces 40 bushels of oranges and 20 bushels of bananas. After specialization, the increase in orange production is ____ 40 ____ bushels of oranges. j) Before specialization, Mexico produces 160 bushels of oranges and 40 bushels of bananas, and Guatemala produces 30 bushels of oranges and 40 bushels of bananas. After specialization, the increase in banana production is ____ 20 ____ bushels of bananas. k) For both countries to benefit from trade, the terms of trade must be between 1:1 and __ 1:2 __ bushel(s) of oranges to bushel(s) of bananas. 7) The table below shows the number of labor hours required to produce a cell phone and a board foot of lumber in Egypt and France. One Cell Phone Lumber (per board foot) Egypt 40 hours 8 hours France 16 hours 4 hours a) Does either Egypt or France have an absolute advantage and if so, in what product? France, in both b) What is Egypt's opportunity cost of producing one cell phone? 5 board feet of lumber c) What is France's opportunity cost of producing one cell phone? 4 board feet of lumber d) What is Egypt's opportunity cost of producing one board foot of lumber? 0.2 cell phones e) What is France's opportunity cost of producing one board foot of lumber? 0.25 cell phones f) Egypt has a comparative advantage in the production of ___ lumber ___. g) France has a comparative advantage in the production of __ cell phones __. h) If the two countries specialize and trade, who should export lumber? Egypt i) If the two countries specialize and trade, who should export cell phones? France

ECON 1011 Prof. Foster ©I. R. Foster 8 8) The figure below shows the production possibilities frontiers for Costa Rica and Guatemala. Each country produces two goods, pineapples and coconuts. Another way to show this information: Production Possibilities Frontier Coconuts (tons) Pineapples (Tons) COSTA RICA 150 100 GUATEMALA 180 90 a) What is the opportunity cost of producing 1 ton of coconuts in Costa Rica? 2/3 of a ton of pineapples b) What is the opportunity cost of producing 1 ton of coconuts in Guatemala? ½ of a ton of pineapples c) What is the opportunity cost of producing 1 ton of pineapples in Costa Rica? 1.5 tons of coconuts d) What is the opportunity cost of producing 1 ton of pineapples in Guatemala? 2 tons of coconuts e) Which country has a comparative advantage in the production of coconuts? Guatemala f) Which country has a comparative advantage in the production of pineapples? Costa Rica g) If the two countries have the same amount of resources and the same technological knowledge, which country has an absolute advantage in the production of both pineapples and coconuts? Neither 9) Refer to the table below. This table shows the number of labor hours required to produce a cell phone and a board foot of lumber in Estonia and Finland. Cell Phone Lumber (board foot ) Estonia 20 hours 5 hours Finland 18 hours 4 hours

ECON 1011 Prof. Foster ©I. R. Foster 9 a) If each country has a total of 3,600 labor hours to devote to the production of the two goods, draw the production possibilities frontier for each country. Put "Cell Phone" on the horizontal axis and "Lumber" on the vertical axis. Be sure to identify the intercept values on your graphs. b) Suppose each country allocates 55% its labor hours to lumber production and 45% to the production of cell phones. Complete the table below to show each country's output of the two products. Production and Consumption with no Trade Cell Phone Output Lumber Output (board feet ) Estonia 81 396 Finland 90 495 Total 171 891 c) If the two countries do not trade and consume whatever they produce, identify the current production and consumption point for each country on their respective production possibilities frontiers. Label Estonia's consumption point " E " and Finland's consumption point, " F ". d) Suppose the two countries specialize and trade. Who should produce cell phones and who should produce lumber? Explain your answer. Opportunity Cost of Producing Cell Phones and Lumber ONE CELL PHONE ONE BOARD FOOT OF LUMBER ESTONIA 4 board feet of lumber 0.25 cell phones FINLAND 4.5 board feet of lumber 0.22 cell phones Estonia – cell phones; Finland – lumber Each country can produce these goods at lower cost (give up less of the other good)

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ECON 1011 Prof. Foster ©I. R. Foster 10 e) Complete the table below to show each country's output with specialization. Output with Specialization Cell Phone Output Lumber Output (board feet ) Estonia 180 0 Finland 0 900 Total 180 900 f) Did specialization increase the combined output for the two countries without any increase in resources? If so, by how much? Yes, cell phone output increases by 9 units (from 171 units to 180 units) and lumber output increases by 9 board feet (from 891 board feet to 900 board feet). g) Suppose Estonia and Finland agree to trade so that in exchange for 400 board feet of lumber, the exporter of lumber receives 90 cell phones. Complete the table below to show each country's consumption bundle after trade. Consumption with Trade Cell Phone Output Lumber Output (board feet ) Estonia 90 400 with trade Finland 90 with trade 500 Total 180 900 h) Show the consumption points after trade on each country's production possibilities frontier. Label these points " X " for Estonia and " Y " for Finland. i) Has trade made the two countries better off? Explain your answer. Consumers in both countries are better off. Cell phone producers in Estonia and lumber producers in Finland are better off. Lumber producers in Estonia and cell phone producers in Finland are worse off. 10) Consider a hypothetical world with only two countries: Germany and Poland. Both are producing only two goods: computers and tons of grain. Suppose a worker in Germany can produce 20 computers or 5 tons of grain per month. Suppose a worker in Poland can produce 4 computers or 4 tons of grain per month. For simplicity, assume each country has 100 workers. Assume that workers are equally skilled at producing either computers or grain. a) Fill in the table below with the number of computers or tons of grain that one worker can produce in both countries. Per Worker Production of Computers and Grain COMPUTERS TONS OF GRAIN GERMANY 20 5 POLAND 4 4

ECON 1011 Prof. Foster ©I. R. Foster 11 b) Complete the PPF table below: Production Possibility Frontiers (PPFs) COMPUTERS TONS OF GRAIN GERMANY 2000 500 POLAND 400 400 c) Draw the production possibilities frontiers (PPFs) for both countries in the grids provided below with computers on the x axis and grain on the y axis. Assume Germany chooses to produce and consume 800 computers and 300 tons of grain and Poland chooses to produce and consumer 200 computers and 200 tons of grain. Depict these points on your graph: d) Which country has an absolute advantage in the production of computers? Grain? Explain . Computers = Germany; Grain = Germany. Germany can produce more of both goods with the same resources (100 workers) as Poland. e) Complete the opportunity cost table below. Specify units. Opportunity Cost of Producing Computers and Grain ONE COMPUTER ONE TON OF GRAIN GERMANY 0.25 tons of grain 4 computers POLAND 1 ton of grain 1 computer f) Which country has a comparative advantage in the production of computers? Grain? Explain your answer. Computers = Germany; Grain = Poland Each country can produce these goods at lower cost (give up less of the other good)

ECON 1011 Prof. Foster ©I. R. Foster 12 g) What is current total world output of the two goods before trade? Total World Production & Consumption without Specialization and Trade COMPUTERS TONS OF GRAIN GERMANY 800 300 POLAND 200 200 TOTAL PRODUCTION 1000 500 h) Suppose the two countries decide to specialize and trade. Who should produce computers and who should produce grain? Complete the table below to show each country's output with specialization. Total World Production with Specialization COMPUTERS TONS OF GRAIN GERMANY 2000 0 POLAND 0 400 TOTAL PRODUCTION 2000 400 i) Suppose Germany and Poland agree to trade so that in exchange for 1000 computers, the exporter of computers receives 300 tons of grain (called the terms of trade). Complete the table below to show each country's consumption bundle after trade. Trade and Consumption After Trade COMPUTERS TONS OF GRAIN GERMANY 1000 300 from trade POLAND 1000 from trade 100 TOTAL PRODUCTION 2000 400 j) Plot the two consumption bundles on your graphs. Has trade made the two countries better off? Why or why not? Explain your answer. Consumers in Germany are better off in terms of computers and doing just as well in terms of grain. Consumers in Poland are better off in terms of computers but are consuming less grain. Computer producers in Germany and grain producers in Poland are better off. Grain producers in Germany and computer producers in Poland are worse off than before. k) Would the two countries agree to terms of trade of two computers for 1 ton of grain? Explain. Germany would agree - less expensive for Germany to get grain from Poland through trade (has to give up 2 computers per ton of grain) than to produce the grain itself (has to give up 4 computers per ton of grain). Poland would agree - less expensive for Poland to get computers from Germany through trade (has to give up 1/2 ton of grain per computer) than to produce the computers itself (has to give up 1 ton of grain per computer). l) Would the two countries agree to terms of trade of one computer for 8 tons of grain? Explain. Germany would agree - less expensive for Germany to get grain from Poland through trade (has to give up 1/8 of a computer per ton of grain) than to produce the grain itself (has to give up 4 computers per ton of grain). Poland would not agree - more expensive for Poland to get computers from Germany through trade (has to give up 8 tons of grain per computer) than to produce the computers itself (has to give up 1 ton of grain per computer)

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ECON 1011 Prof. Foster ©I. R. Foster 13 11) The following table shows the opportunity costs of producing handbags and jackets in Cambodia and Thailand. Opportunity Cost of Producing 1 Handbag Opportunity Cost of Producing 1 Jacket Cambodia 0.20 jackets 5 handbags Thailand 0.25 jackets 4 handbags a) Would Cambodia agree to terms of trade of 1 handbag for 2 jackets? Explain why or why not. Cambodia specializes in the production of handbags. Cambodia has to decide whether to also produce jackets themselves (cost is 5 handbags per jacket (from PPF)) or trade for them with Thailand (cost is ½ a handbag for a jacket (from terms of trade)). Cambodia will choose to trade as it will have to give up fewer handbags. b) Would Thailand agree to terms of trade of 1 handbag for 2 jackets? Explain why or why not. Thailand specializes in the production of jackets. Thailand has to decide whether to also produce handbags themselves (cost is 0.25 jackets per handbag (from PPF)) or trade for them with Cambodia (cost is 2 jackets for a handbag (from terms of trade)). Thailand will not trade as they will have to give up too many jackets.

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