Microecon HW3

Suppose Germany produces two types of goods: agricultural and capital. The following diagram shows its current production possibilities frontier for wheat, an agricultural good, and industrial robots, a capital good. Drag the production possibilities frontier (PPF) on the graph to show the effects of a long drought that reduces the amount of water available for farmers to use for irrigation.

Because of the drought, fewer bushels of wheat can be produced on any given amount of land; however, there is no reason to think that the maximum amount of industrial robots that can be produced would change. For instance, when you look at the vertical axis, you see that if Germany produces zero bushels of wheat, it can initially produce a maximum of 60,000 industrial robots per year. Because the drought does not affect the number of industrial robots Germany can produce, you should have left the point at 60,000 industrial robots per year. Similarly, when you look at the horizontal axis, you see that if Germany produces zero industrial robots, it can initially produce a maximum of 180 million bushels of wheat per year. Because the drought decreases the amount of wheat Germany can produce, you should have moved the point to 120 million bushels of wheat per year.

Suppose Ireland produces two types of goods: agricultural and capital. The following diagram shows its current production possibilities frontier for corn, an agricultural good, and construction vehicles, a capital good. Drag the production possibilities frontier (PPF) on the graph to show the effects of an immigration law that results in fewer workers entering the country.

Because of the immigration law, less labor is available for the production of both corn and construction vehicles. For instance, when you look at the vertical axis, you see that if Ireland produces zero bushels of corn, it can initially produce a maximum of 270,000 construction vehicles per year. Because the immigration law decreases the number of construction vehicles Ireland can produce, you should have moved the point to 180,000 construction vehicles per year. Similarly, when you look at the horizontal axis, you see that if Ireland produces zero construction vehicles, it can initially produce a maximum of 300 million bushels of corn per year. Because the immigration law decreases the amount of corn Ireland can produce, you should have moved the point to 200 million bushels of corn per year.

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 Rye (Bushels per acre) (Bushels per acre) Eric 30 10 Ginny 28 7

Eric has an absolute advantage in the production of corn, and Eric has an absolute advantage in the production of rye. => 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 3 Bushels of corn, whereas Ginny's opportunity cost of producing 1 bushel of rye is 4 Bushels of corn. Because Eric has a lower opportunity cost of producing rye than Ginny, Eric has a comparative advantage in the production of rye, and Ginny has a comparative advantage in the production of corn. => 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 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 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.

Inefficient, Efficient, Attainable

Points located inside the production possibilities frontier, such as F and A, represent inefficient output combinations. At these points, it is possible to increase the production of both goods because some resources are unemployed. For example, point F is inefficient because it is possible for Bulgaria to produce at point E instead, where the economy is producing both more corn and more blu rays. Points located on the production possibilities frontier, such as D and E, represent efficient output combinations. At these points, it is impossible to increase the production of one good without producing less of the other. For instance, if Bulgaria is currently producing at point E and decides that it wants to produce more corn, it must produce fewer blu rays. Points located outside the production possibilities frontier, such as B and C, represent output combinations that are unattainable, given current resources and technology. Recall that each point on the production possibilities frontier shows the maximum quantity of corn Bulgaria can produce if it also wants to produce the given quantity of blu rays. For example, compare point E (36 million blu rays and 46 million bushels of corn) with point C (36 million blu rays and 80 million bushels of corn). Because point E is on Bulgaria's production possibilities frontier, you can see that if Bulgaria is producing 36 million blu rays, it can produce at most 46 million bushels of corn. Therefore, point C must be unattainable, given current resources and technology.

4 . Specialization and production possibilities Suppose China produces only tablets and cars. The resources that are used in the production of these two goods are SPECIALIZE—that is, some resources are more suitable for producing tablets than cars, whereas others are more suitable for producing cars than tablets. The shape of China's production possibilities frontier (PPF) should reflect the fact that as China produces more cars and fewer tablets, the opportunity cost of producing each additional car _____

Recall that some resources are more suitable for producing tablets than cars, whereas others are more suitable for producing cars than tablets. This means that if China decides to produce more tablets and fewer cars, the resources that it uses to produce the additional tablets will be less suited to the production of tablets than the resources already being used in tablet production. Therefore, the opportunity cost of producing each additional tablet increases as more tablets are produced.

Suppose Argentina produces only smartphones and tablets. 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 tablets and smartphones. The shape of Argentina's production possibilities frontier (PPF) should reflect the fact that as Argentina produces more tablets and fewer smartphones, the opportunity cost of producing each additional tablet ______.

Recall that the same set of resources is equally useful in producing both tablets and smartphones. This means that if Argentina decides to produce more smartphones and fewer tablets, the resources that it uses to produce the additional smartphones will be as well suited to the production of smartphones as the resources already being used in smartphone production. Therefore, the opportunity cost of producing each additional smartphone remains constant as more smartphones are produced. For bowed-out PPFs, the opportunity cost of producing smartphones is reflected in the curvature of the PPF. In flatter regions, producing an additional tablet requires giving up fewer smartphones. However, in steeper regions, producing an additional tablet requires giving up more smartphones. In other words, the opportunity cost of producing tablets changes as you move along the PPF. For linear PPFs, the opportunity cost of producing tablets is constant and reflected in the slope of the PPF. If the PPF is flatter, producing an additional tablet requires giving up fewer smartphones. If the PPF is steeper, producing an additional tablet requires giving up more smartphones. In this case, because the opportunity cost of producing additional tablets remains constant as more resources are shifted to the production of tablets, the PPF must be linear. Therefore, Graph 1 best represents the trade-off Argentina faces between producing tablets and smartphones.

8 . The price of trade Suppose that Spain and Switzerland both produce beer and stained glass. Spain's opportunity cost of producing a pane of stained glass is 3 barrels of beer while Switzerland's opportunity cost of producing a pane of stained glass is 11 barrels of beer. By comparing the opportunity cost of producing stained glass in the two countries, you can tell that (Spain) has a comparative advantage in the production of stained glass and (Switzerland) has a comparative advantage in the production of beer. Based on your answer to the last question, which of the following prices of trade (that is, price of stained glass in terms of beer) would allow both Switzerland and Spain to gain from trade? Check all that apply. Correct 7 barrels of beer per pane of stained glass Correct 10 barrels of beer per pane of stained glass Correct 1 barrel of beer per pane of stained glass Correct 13 barrels of beer per pane of stained glass

The production of stained glass. That is, Spain has to give up only 3 barrels of beer to produce a pane of stained glass while Switzerland must give up 11 barrels of beer to produce a pane of stained glass. Another way to think of it is that it is cheaper for Spain to produce stained glass than it is for Switzerland. Therefore, it is better for Spain to specialize in the production of stained glass. You can determine the opportunity cost of beer in terms of stained glass from the opportunity cost of stained glass in terms of beer. For example, Spain's opportunity cost of producing a pane of stained glass is 3 barrels of beer. Therefore, Spain can produce 3 barrels of beer if it forgoes the production of 1 pane of stained glass. This means that Spain's opportunity cost of producing a barrel of beer is 1/3 of a pane of stained glass. Similarly, Switzerland's opportunity cost of producing a pane of stained glass is 11 barrels of beer, so Switzerland's opportunity cost of producing a barrel of beer is 1/11 of a pane of stained glass. Since Switzerland has a lower opportunity cost for the production of beer than Spain does, it has a comparative advantage in the production of beer. Recall that Spain will gain from trade if it gets more than 3 barrels of beer for each pane of stained glass it exports. Similarly, Switzerland will trade beer only if it gets more than 1/11 pane of stained glass for each barrel of beer it exports. Another way of saying this is that Switzerland is willing to trade up to 11 barrels of beer for each pane of stained glass it imports. Therefore, any price ratio that involves stained glass selling for between 3 and 11 barrels of beer per pane of stained glass will benefit both countries. Any price below 3 barrels of beer per pane of stained glass would benefit Switzerland but not Spain; similarly, any price above 11 barrels of beer per pane of stained glass would benefit Spain but not Switzerland.

Kenji is a skilled toy maker who is able to produce both trains and balls. He has 8 hours a day to produce toys. The following table shows the daily output resulting from various possible combinations of his time. Choice Hours Producing Produced (Trains) (Balls) (Trains) (Balls) A 8 0 4 0 B 6 2 3 12 C 4 4 2 17 D 2 6 1 19 E 0 8 0 20 Because he can now make more trains per hour, Kenji's opportunity cost of producing balls is (higher) than it was previously.

When using combination D, Kenji is producing one train and 19 balls per day. Producing a second train per day would require him to move to combination C, reducing his production of balls to 17 per day. Since this change involves producing 2 fewer balls per day ( 19−17=2 ), the opportunity cost of producing the second train per day is 2 balls per day. Similarly, using combination C, Kenji is producing two trains and 17 balls per day. Producing a third train per day would require him to move to combination B, reducing his production of balls to 12 per day. Since this change involves producing 5 fewer balls per day ( 17−12=5 ), the opportunity cost of producing the third train per day is 5 balls per day. Kenji's opportunity cost of producing the second train per day is 2 balls per day while the opportunity cost of producing the third train per day is 5 balls per day. Hence, as Kenji increases his production of trains, his opportunity cost of producing more trains increases. This change is an example of the law of increasing opportunity costs. The shift in Kenji's PPF is reflected in a corresponding change in his opportunity costs. Again, consider combination D, and consider the effects of moving from there to combination E. Both before and after Kenji buys the tool, he can produce 19 balls if he devotes 6 hours to producing them and 20 balls if he devotes 8 hours to producing them. Therefore, spending his last 2 hours producing balls results in one additional ball. Before he bought the tool, he would have to give up one train. However, now that he has the tool, it means giving up two trains. Therefore, Kenji's increased ability to produce trains increases his opportunity cost of producing balls.