SOLUTIONS TO TEXT PROBLEMS:

Transcription

1 44 Chapter 3/Interdependence and the Gains from Trade SOLUTIONS TO TEXT PROBLEMS: Quick Quizzes The answers to the Quick Quizzes can also be found near the end of the textbook. 1. Figure 1 shows Robinson Crusoe s production possibilities frontier for gathering coconuts and catching fish. If Crusoe lives by himself, this frontier limits his consumption of coconuts and fish, but if he can trade with natives on the island, he will possibly be able to consume at a point outside his production possibilities frontier. Figure 1 2. Crusoe s opportunity cost of catching one fish is 10 coconuts, since he can gather 10 coconuts in the same amount of time it takes to catch one fish. Friday s opportunity cost of catching one fish is 15 coconuts, since he can gather 30 coconuts in the same amount of time it takes to catch two fish. Friday has an absolute advantage in catching fish, since he can catch two per hour, while Crusoe can catch only one per hour. But Crusoe has a comparative advantage in catching fish, since his opportunity cost of catching a fish is less than Friday s. 3. If the world s fastest typist happens to be trained in brain surgery, he should hire a secretary because the secretary will give up less for each hour spent typing. Although the brain surgeon has an absolute advantage in typing, the secretary has a comparative advantage in typing because of the lower opportunity cost of typing. Questions for Review 1. Absolute advantage reflects a comparison of the productivity of one person, firm, or nation to that of another, while comparative advantage is based on the relative opportunity costs of the persons, firms, or nations. While a person, firm, or nation may have an absolute advantage in producing every good, they cannot have a comparative advantage in every good. 2. Many examples are possible. Suppose, for example, that Roger can prepare a meal of hot dogs and macaroni in just ten minutes, while it takes Anita 20 minutes. Also suppose that Roger can do all the laundry in three hours, while it takes Anita four hours. Roger has an absolute

2 Chapter 3/Interdependence and the Gains from Trade 45 advantage in both cooking and doing the laundry, but Anita has a comparative advantage in doing the laundry. For Anita, the opportunity cost of doing the laundry is 12 meals; for Roger, it is 18 meals. 3. Comparative advantage is more important for trade than absolute advantage. In the example in problem 2, Anita and Roger will complete their chores more quickly if Anita does at least some of the laundry and Roger cooks the meals for both, because Anita has a comparative advantage in doing the laundry, while Roger has a comparative advantage in cooking. 4. A nation will export goods for which it has a comparative advantage because it has a smaller opportunity cost of producing those goods. As a result, citizens of all nations are able to consume quantities of goods that are outside their production possibilities frontiers. 5. Economists oppose policies that restrict trade among nations because trade allows all countries to achieve greater prosperity by allowing them to receive the gains from comparative advantage. Restrictions on trade hurt all countries. Problems and Applications 1. a. See Figure 2. If Maria spends all five hours studying economics, she can read 100 pages, so that is the vertical intercept of the production possibilities frontier. If she spends all five hours studying sociology, she can read 250 pages, so that is the horizontal intercept. The opportunity costs are constant, so the production possibilities frontier is a straight line. Figure 2 b. It takes Maria two hours to read 100 pages of sociology. In that time, she could read 40 pages of economics. So the opportunity cost of 100 pages of sociology is 40 pages of economics.

3 46 Chapter 3/Interdependence and the Gains from Trade 2. a. Workers needed to make: One T-shirt One Dozen Brownies U.S. 1/10 1/18 Mexico 1/10 1/10 b. See Figure 3. With 1 million workers and 10 T-shirts per worker, if either economy were devoted completely to T-shirts, it could make 10 million T-shirts. Because a U.S. worker can produce 18 dozen brownies, if the United States produced only brownies it would produce 18 million dozen. Because a Mexican worker can produce 10 dozen brownies, if Mexico produced only brownies it would produce 10 million dozen. These are the intercepts of the production possibilities frontiers shown in the figure. Note that because the trade-off between T-shirts and brownies is constant for both countries, the production possibilities frontiers are straight lines. Figure 3 c. Because a U.S. worker produces either 10 T-shirts or 18 dozen brownies, the opportunity cost of one T-shirt is 1 4/5 dozen brownies, which is 18 divided by 10. Because a Mexican worker produces either 10 T-shirts or 10 dozen brownies, the opportunity cost of one T-shirt is one dozen brownies, which is 10 divided by 10. Similarly, the U.S. opportunity cost of one dozen brownies is 5/9 T-shirt (10 divided by 18) and the Mexican opportunity cost of one dozen brownies is 1 T-shirt (10 divided by 10). This results in the following table:

4 Chapter 3/Interdependence and the Gains from Trade 47 Opportunity Cost of: One T-shirt (in terms of dozens of brownies given up) One Dozen Brownies (in terms of T-shirts given up) U.S. 1 4/5 5/9 Mexico 1 1 d. Neither country has an absolute advantage in producing T-shirts, because they are equally productive (the same output per worker); the United States has an absolute advantage in producing brownies, because it is more productive (greater output per worker). e. Mexico has a comparative advantage in producing T-shirts, because it has a lower opportunity cost in terms of brownies given up. The United States has a comparative advantage in producing brownies, because it has a lower opportunity cost in terms of T- shirts given up. f. With half the workers in each country producing each of the goods, the United States would produce 5 million T-shirts (500,000 workers times 10 T-shirts each) and 9 million dozen brownies (500,000 workers times 18 dozen each). Mexico would produce 5 million T-shirts (500,000 workers times 10 T-shirt each) and 5 million dozen brownies (500,000 million workers times 10 dozen each). g. From any situation with no trade, in which each country is producing some T-shirts and some brownies, suppose the United States changed one worker from producing T-shirts to producing brownies. That worker would produce 10 fewer T-shirts and 18 additional dozen brownies. Then suppose the United States offers to trade eight dozen brownies to Mexico for five T-shirts. The United States will do this because it values five T-shirts at nine dozen brownies, so it will be better off if the trade goes through. Mexico will take the trade because it values five T-shirts at five dozen brownies, so it will be better off. Thus, by trading and changing their production, both countries are better off. 3. a. Martha s opportunity cost of knitting a scarf is two dozen meatballs. Martha has an absolute advantage in knitting a scarf because she can make one in two hours, while it takes Stewart three hours. Stewart s opportunity cost of knitting a scarf is one and one half dozen meatballs. Because Stewart s opportunity cost of knitting a scarf is less than Martha s, Stewart has a comparative advantage in knitting scarves. b. Because Stewart has a comparative advantage in knitting scarves, he will knit scarves and exchange it for meatballs that Martha makes. c. The highest price of a scarf in terms of meatballs that will make both spouses better off is 2 dozen meatballs. If the price were higher than that, then Martha would prefer knitting her own scarf (at an opportunity cost of two dozen meatballs) rather than trade for a scarf that Stewart makes. The lowest price of a scarf in terms of meatballs that will make both spouses better off is one and one half dozen meatballs. If the price were lower than that, then Stewart would prefer making his own meatballs (he can make one and one-half dozen instead of knitting a scarf) rather than trading for meatballs that Martha makes.

5 48 Chapter 3/Interdependence and the Gains from Trade 4. a. Because a Canadian worker can make either two cars a year or 30 bushels of wheat, the opportunity cost of a car is 15 bushels of wheat. Similarly, the opportunity cost of a bushel of wheat is 1/15 of a car. The opportunity costs are the reciprocals of each other. b. See Figure 4. If all ten million workers produce two cars each, they produce a total of 20 million cars, which is the vertical intercept of the production possibilities frontier. If all ten million workers produce 30 bushels of wheat each, they produce a total of 300 million bushels, which is the horizontal intercept of the production possibilities frontier. Because the trade-off between cars and wheat is always the same, the production possibilities frontier is a straight line. If Canada chooses to consume ten million cars, it will need five million workers devoted to car production. That leaves five million workers to produce wheat, who will produce a total of 150 million bushels (five million workers times 30 bushels per worker). This is shown as point A on Figure 4. c. If the United States buys 10 million cars from Canada and Canada continues to consume 10 million cars, then Canada will need to produce a total of 20 million cars. So Canada will be producing at the vertical intercept of the production possibilities frontier. However, if Canada gets 20 bushels of wheat per car, it will be able to consume 200 million bushels of wheat, along with the 10 million cars. This is shown as point B in the figure. Canada should accept the deal because it gets the same number of cars and 50 million more bushes of wheat. Figure 4 5. a. Italian workers have an absolute advantage over Greek workers in producing bread, because Italian workers produce more loaves per hour (10 vs. 8). Greek workers have an absolute advantage over Italian workers in producing olive oil, because Greek workers produce more olive oil per hour (8 bottles vs. 5 bottles). Comparative advantage runs the same way. Italian workers, who have an opportunity cost of 1/2 bottle of olive oil per loaf of bread (5 bottles of olive oil per hour divided by 10 loaves of bread per hour), have a comparative advantage in bread production over Greek workers, who have an

6 Chapter 3/Interdependence and the Gains from Trade 49 opportunity cost of 1 bottle of olive oil per loaf of bread (8 bottles of olive oil per hour divided by 8 loaves of bread per hour). Greek workers, who have an opportunity cost of 1 loaf of bread per bottle of olive oil (8 loaves per hour divided by 8 bottles per hour), have a comparative advantage in the production of olive oil over Italian workers, who have an opportunity cost of 2 loaves per bottle (10 loaves per hour divided by 5 bottles per hour). b. If Italy and Greece decide to trade, Greece will produce olive oil and trade it for loaves of bread produced in Italy. A trade with a price between 1 and 2 loaves of bread per bottle of olive oil will benefit both countries, as they will be getting the traded good at a lower price than their opportunity cost of producing the good in their own country. c. Even if a Greek worker produced just 5 bottles of olive oil per hour, the countries would still gain from trade, because Greece would still have a comparative advantage in producing olive oil. Its opportunity cost for olive oil would be higher than before (1 3/5 loaves per bottle, instead of 1 loaf per bottle before). But there are still gains from trade because Italy has a higher opportunity cost (2 loaves per bottle). 6. a. With no trade, one pair of white socks trades for one pair of red socks in Boston, because productivity is the same for the two types of socks. The price in Chicago is two pairs of red socks per pair of white socks. b. Boston has an absolute advantage in the production of both types of socks, because a worker in Boston produces more (three pairs of socks per hour) than a worker in Chicago (two pairs of red socks per hour or one pair of white socks per hour). Chicago has a comparative advantage in producing red socks, because the opportunity cost of producing a pair of red socks in Chicago is one-half pair of white socks, while the opportunity cost of producing a pair of red socks in Boston is one pair of white socks. Boston has a comparative advantage in producing white socks, because the opportunity cost of producing a pair of white socks in Boston is one pair of red socks, while the opportunity cost of producing a pair of white socks in Chicago is two pairs of red socks. c. If they trade socks, Boston will produce white socks for export, because it has the comparative advantage in white socks, while Chicago produces red socks for export, which is Chicago s comparative advantage. d. Trade can occur at any price between one and two pairs of red socks per pair of white socks. At a price lower than one pair of red socks per pair of white socks, Boston will choose to produce its own red socks (at a cost of one pair of red socks per pair of white socks) instead of buying them from Chicago. At a price higher than two pairs of red socks per pair of white socks, Chicago will choose to produce its own white socks (at a cost of two pairs of red socks per pair of white socks) instead of buying them from Boston.

7 50 Chapter 3/Interdependence and the Gains from Trade 7. a. The production possibilities frontiers for the two countries are shown in Figure 5. If, without trade, a U.S. worker spends half of his time producing each good, the United States will have 100 pillows and 15 televisions. If, without trade, a worker in Pakistan spends half of his time producing each good, Pakistan will have 100 pillows and 9 televisions. Figure 5 b. For the United States, the opportunity cost of one television is 6 2/3 pillows, while the opportunity cost of one pillow is 3/20 television. For Pakistan, the opportunity cost of one television is 11 1/9 pillows, while the opportunity cost of one pillow is 9/100 television. Therefore, the United States has a comparative advantage in the production of televisions and Pakistan has a comparative advantage in the production of pillows. Pakistan would export pillows. The price of a pillow will fall between 9/100 and 15/100 of a television. An example would be a price of 10/100 television. In other words, Pakistan could export 10 pillows and receive one television in return. Both countries would benefit from trade. Pakistan would specialize in pillows (producing 200) and export 10. This would leave them with 190 pillows. In return, they would get one television. The combination of 190 pillows and 1 television was not available to Pakistan before trade. The United States could specialize in televisions (producing 30) and export one television to Pakistan in exchange for ten pillows. The United States would end up with 29 televisions and 10 pillows, a combination that was impossible without trade. c. The price of a television would fall between 6 2/3 and 11 1/9 pillows. If the price was below 6 2/3 pillows, the United States would not be willing to export televisions because the opportunity cost of a television for the United States is 6 2/3 pillows. If the price was greater than 11 1/9 pillows, Pakistan would not be willing to import televisions because (for Pakistan) the opportunity cost of a television is 11 1/9 pillows. d. Once the productivity is the same in the two countries, the benefits of trade disappear. Trade is beneficial because it allows countries to exploit their comparative advantage. If Pakistan and the United States have exactly the same opportunity cost of producing shirts and computers, there will be no more gains from trade available.

8 Chapter 3/Interdependence and the Gains from Trade a. True; two countries can achieve gains from trade even if one of the countries has an absolute advantage in the production of all goods. All that is necessary is that each country have a comparative advantage in some good. b. False; it is not true that some people have a comparative advantage in everything they do. In fact, no one can have a comparative advantage in everything. Comparative advantage reflects the opportunity cost of one good or activity in terms of another. If you have a comparative advantage in one thing, you must have a comparative disadvantage in the other thing. c. False; it is not true that if a trade is good for one person, it cannot be good for the other one. Trades can and do benefit both sides especially trades based on comparative advantage. If both sides did not benefit, trades would never occur. d. False; trade that makes the country better off can harm certain individuals in the country. For example, suppose a country has a comparative advantage in producing wheat and a comparative disadvantage in producing cars. Exporting wheat and importing cars will benefit the nation as a whole, as it will be able to consume more of all goods. However, the introduction of trade will likely be harmful to domestic autoworkers and manufacturers. 9. This pattern of trade is consistent with the principle of comparative advantage. If the United States exports corn and aircraft, it must have a comparative advantage in the production of these goods. Because it imports oil and clothing, the United States must have a comparative disadvantage in the production of these items.