Answers to Practice Questions on Comparative Advantage Dr. McGahagan -- Microeconomics The following information applies to questions 1 - 6. Good X is X-ray machines, and good Y is yogurt. In Australia, a worker can produce 10 units of good X a week or 70 gallons of good Y a week. In Burma, a worker can produces 5 X-ray machines a week or 50 gallons of good Y a week. Wages in Australia are 500 Australian dollars a week; wages in Burma are 1000 Burmese kyats a week. Note that the question can be translated into the following productivity relations: Australia Burma
Good X X = 10 Lx X = 5 Lx
Good Y Y = 70 Ly Y = 50 Ly
___1. How does the above relate to the absolute and comparative advantages of Austrialia and Burma? d. Australia has the absolute advantage in both goods; Burma has the comparative advantage in good Y. Australian workers can outproduce Burmese in both goods, but while they produce twice as much of good X, they produce less than twice as much (more exactly 7/5 or 1.4 times as much) of good Y Burma has less of a disadvantage in Y= comparative advantage in Y ____2. The activity requirements in Burma will be: c. 1/5 for X-ray machines and 1/50 for yogurt. Activity requirements are the reciprocal of productivity; if a Burmese worker can produce 5 units of good X a week, it takes him 1/5 of a week to produce 1 unit. ____3. If the wage in Burma is 1000 kyats a week, the minimum possible price of X-ray machines would be: b. 200 kyats Since it costs 1000 kyats to hire one worker, and the worker can produce 5 X a week, the cost of production of 1 X is 1000 kyats / 5 = 200 kyats ____4. If the price of a gallon of yogurt in Burma is 400 kyats, the maximum possible wage in Burma would be: e. 20,000 kyats. Since workers can produce 50 gallons of yogurt a week, the cost of production at that wage would be 20,000 / 50 = 400 kyats. ____5. In the above example, the opportunity cost of an X-ray machine in Australia is ---- and the opportunity cost of an X-ray machine in Burma is ----. a. 7 gallons of yogurt; 10 gallons of yogurt. Since one Australian can produce either 10 X or 70 Y, the opportunity cost of one X is 7 Y in Australia. Since one Burmese can produce either 5 X or 50 Y, the opportunity cost of one X is 7 Y in Burma. Question 6. (Graphical; use a separate sheet of paper). Assume that each country has a work force of 42 million. Sketch the (straight line) production possibility frontiers of each. Australian intercepts will be: Max. production of X = 42 * 10 = 420; Max. production of Y = 42 *70 = 2940 Burmese intercepts will be: Max. production of X = 42 * 5 = 210; Max. production of Y = 42 * 50 = 2100
________7. Andorra can produce a maximum of 2500 wool blankets a month OR a maximum of 5000 leather wineskins a month. The workforce in Andorra is 1000 workers. The wage of an Andorran worker is 2000 euros a month. What is the opportunity cost of producing another wool blanket? b. Two wineskins The opportunity cost of 2500 wool blankets is 5000 leather wineskins, so the OC of 1 blanket is 2 wineskins ______8. Given the data on Andorra from the last problem, what is the activity requirement for blankets in Andorra? d. 1 / 2.5 = 0.4 months of work per blanket. 2.5 blankets per month shows worker productivity; its reciprocal is the activity requirement. __________________9. The price of blankets in Andorra (assuming that labor costs are the only costs of production) will be: --- (fill in the blank with the appropriate number; use the proper units for the price). Since each worker produces 2.5 blankets, and costs the firm 2000 euros, the minimum possible price is 2000 / 2.5 = 800 euros. ___________________10. The relative price of blankets in Andorra will be:--The price of wineskins will be 2000 / 5 = 400 euros, so the relative price of blankets is 800 / 400 = 2 Note that relative price is a pure number, so the proper units are not euros. The relative price tells you that blankets are twice as expensive as euros. ______11. Suppose Andorra enters into trade with Spain, which can produce a maximum of 25,000 wool blankets a month OR a maximum of 100,000 wineskins per month with its workforce of 20,000 workers. We can conclude from these numbers that: e. Spain has a absolute advantage in neither good. Although Spain can produce more blankets and more wineskins than Andorra, it takes a higher per worker input to do so. The Spanish worker can produce 25,000/20,000 = 1.25 blankets to Andorra's 2.5 per worker The Spanish worker can produce 100,000 / 20,000 = 5 blankets to Andorra's 5 per worker. (tie in productivity) Since Spanish productivity is lower overall, Spain will have a lower standard of living. _____12. In the Andorra-Spain example of the last question, the pattern of trade expected on the basis of the Ricardian model would be: d. Andorra will export blankets to Spain; Spain will export wineskins to Andorra. 13. Explain your answer to questions 11 and 12, using the terms "comparative advantage", "absolute advantage" and "opportunity cost" below: The opportunity cost of 25,000 blankets in Spain is 100,000 wineskins, since Spain has the choice between these two extremes. That means that in producing one blanket, Spain gives up the opportunity to produce 4 wineskins (See Question 7 for Andorra's lower OC of blankets) It also means that in producing 1 wineskin, Spain gives up the opportunity to produce ¼ blanket. And that gives the Spanish the comparative advantage in wineskins, since it has a lower opportunity cost than Andorra (where the OC of wineskins is ½ blanket).
_____14. Recall that the maximum production in Andorra was either 2500 blankets or 5000 wineskins. Let blankets be good X and wineskins be good Y. The equation of the production possiblity frontier (supposing it is a straight line) will be: c. Y = 5000 - 2 X Given the equation for the Andorran production possibility frontier, are the following production bundles: A. Efficient. B. Inefficient C. Impossible to attain Again, assume a straight line PPF. Show your calculations. Substitute the value of blankets in the equation of the PPF to see whether you can produce A. exactly the number of wineskins claimed in each of the following questions (so the choice is efficient). B. more than the number of wineskins claimed(the choice would be inside the PPF, and so inefficient). C. fewer than the number of wineskins claimed (the choice would be outside the PPF, and so impossible). It helps to draw a PPF and to locate the points below on that graph (use graph paper to be exact) __A_15. 1250 blankets and 2500 wineskins, since Y = 5000 – 2*1250 = 2500 wineskins __A__16. 1000 blankets and 3000 wineskins, since Y = 5000 – 2 * 1000 = 3000 wineskins __B__17. 500 blankets and 2000 wineskins, since Y = 5000 – 2*500 = 4000 wineskins. Note that this means you could have produced 4000 wineskins if you decide to produce 500 blankets. You are under your production possibilities if you decided to produce only 2000 wineskins. _B_18. 1500 blankets and 1500 wineskins, since Y = 5000 – 2 * 1500 = 2000 wineskins. How would the Andorran PPF change in response to the following changes? Your options are: A. The PPF would not change at all, but Andorra would move to a different point on the PPF B. The PPF would shift outwards parallel to itself. C. The PPF would shift inwards parallel to itself. D. the PPF would rotate, and the slope of the PPF would be steeper (recall that wineskins = Y). E. the PPF would rotate, and the slope of the PPF would be flatter (recall that wineskins = Y). Drawing a graph of the PPF would again help. Note that the slope of the PPF shows relative prices, and that being able to produce more of one good, but not of the other, will be an increase in supply which lowers its relative price. __B_19. The Andorran workforce increases. (more of either good could be produced) __D__20. Andorran sheep die off due to a sheep-specific disease; Andorran cattle are unaffected. (production of wineskins doesn't change, but fewer sheep means fewer wool blankets) __D__21. A leather-sewing machine is invented that makes it possible to manufacture wineskins more rapidly. (production of wineskins increases, of blankets remains the same) __E__22. Power looms make it possible to manufacture blankets more rapidly. __A__23. Andorran consumers decide that they want fewer wool blankets due to global warming. __A__24. Andorra enters into trade and exports one of the goods to Spain. __C_25. In which of the above cases would the relative price of wineskins increase? A. Question 19. No change in relative prices, shown by the slope of the PPF. B. Question 21. Wineskins are cheaper to produce, so their relative price will fall. C. Question 22. Blankets are cheaper to produce, so the relative price of wineskins increases. D. Question 23. Moves along the PPF, so does not change the relative price.
