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Chapter 2 Comparative Advantage Additional Question #1, 2 End-of-Chapter Exercise #9, 10 What is PPF? PPF: The maximum obtainable amount of good each individual can produce • Straight Line PPF Food •1person economy •Comparative Advantage does not take place 24 •Slope is constant, so does opportunity cost 16 8 4 4 8 10 12 •Constant opportunity cost implies that when increasing production of one good, the same amount of the other good must be sacrificed Computer • Bow-out shape PPF Food •More than 2 person economy •Comparative Advantage takes place •Slope is increasing as moving downward, so does opportunity cost - when increasing production of one good, a larger amount of the other good must be sacrificed •Why is PPF bow-shaped? Computer - Increasing Opportunity Cost Principle / Low-Hanging Fruit Principle - “In expanding the production of any good, first employ the resource with the lowest opportunity cost, then turn to the resource with the highest opportunity cost.” • Bow-shaped PPF •Consider an example: •Assume there are 4 workers in the economy, with worker #1 has the lowest opportunity cost in producing computer, with worker #2 the highest •Economy is initially producing the maximum amount of food and zero production in computer •Who should be the first worker to produce the additional unit of computer? Food •Worker #1, because he has the lowest opportunity cost and implies that he is giving up less resources to produce an additional computer. He has little impact on the opportunity cost of computer production. Computer •Worker #4 will be the last worker to move from food industry to produce the additional unit of computer, since he has the highest opportunity cost. This implies the Increasing opportunity cost / Low-fruit hanging principle. Chapter 2, Additional Question (1) The diagram shows Steven's Production Possibilities for one day. Steven could move from the bold PPC to the dashed PPC by Hours studying per day 9 8 8 9 Hours at work per day A) finding a job that paid a higher wage. B) studying fewer hours but more effectively per hour. C) devoting fewer hours to sleeping D) spending more time on leisure activities. E) spending more time on the activity for which he has a comparative advantage. Solution to Addition Question 1 (2) -What is the factor that shift the PPF? -What is the “resource” you use in studying and working? -X-axis/y-axis: measuring in “hours”, i.e. TIME -24 hours a day: working, studying, sleeping, leisure activities Hours studying per day 9 Bold PPF: - The maximum working and studying hours per day is 8 hours - The remaining hours will spend on sleeping and leisure activities 8 Dashed PPF: -The maximum working and studying hours per day is 9 hours - The remaining hours will spend on sleeping and leisure activities 8 9 Hours at work per day Solution to Addition Question 1 (2) How will each of them affect ppf? A) finding a job that paid a higher wage. - won’t cause a parallel shift up of PPF B) studying fewer hours but more effectively per hour. - studying hours decrease, working hours increase D) spending more time on leisure activities. - less hours on both working and studying , PPF shifts inward E) spending more time on the activity for which he has a comparative advantage. - not relevant, only 1 person in this economy C) devoting fewer hours to sleeping - more hours on studying and working, PPF shifts outward ANS: C Chapter 2, Additional Question (2) According to the PPF, moving from a grade of 80 in economics to a grade of 90 in economics: A) is inefficient B) comes at a lower Physics opportunity cost than Grade moving from a 90 to a 100 Grade A in economics. 90 B C) is not feasible. 80 D) comes at a higher C 70 opportunity cost than moving from a 90 to a 100 D 60 in economics. E) is an increase in efficiency. 50 40 40 50 60 70 80 90 E 100 Economics Grade Economics Grade Solution to Addition Question 2 (1) Moving from C to D: -where on the PPF are the attainable and efficient points? -Points that lie along the PPF are said to be attainable and efficient -Points that lie within the PPF are said to be attainable but inefficient -Points that lie outside the PPF are said to be unattainable Physics Grade Grade A 90 B 80 C 70 D 60 50 40 40 50 60 70 80 90 Refer to the Question, moving from C to D: A) is inefficient ? C) is not feasible? E) is an increase in efficiency? NO! E 100 Economics Grade Economics Grade Solution to Addition Question 2 (2) Refer to the Question: B) comes at a lower opportunity cost than moving from a 90 to a 100 in economics. D) comes at a higher opportunity cost than moving from a 90 to a 100 in economics. Physics Grade Moving from C to D Grade -increase econ by 10 grades -decrease phy by 10 grades (TRADEOFF) -oppo. Cost = 1 econ grade: 1 phy grade A 90 B 80 Moving from D to E -increase econ by 10 grades -decrease phy by 60 grades -oppo. Cost = 1 econ grade: 6 phy grade C 70 D 60 50 40 40 50 60 70 80 90 E 100 Economics Grade Economics Grade ANS: B Chapter 2, Problem 9 • Susan can pick 4 pounds of coffee in an hour or gather 2 pounds of nuts. Tom can pick 2 pounds of coffee in an hour or gather 4 pounds of nuts. Each works 6 hours per day. Solution to Problem 9 (1) a) What is the maximum number of pounds of coffee the two can pick in a day? • There is a time constraint of 6 hours for a day Coffee / hour Nuts / hour Susan 4 pounds 2 pounds Tom 2 pounds 4 pounds •Susan can pick 24 pounds of coffee a day (4 pounds per hour x 6 hours per day) •Tom can pick 12 pounds of coffee a day (2 pounds per hour x 6 hours per day) •Therefore they can gather a total of 36 pounds of coffee a day Solution to Problem 9 (2) b) What is the maximum number of pounds of nuts the two can pick in a day? • There is a time constraint of 6 hours for a day Coffee / hour Nuts / hour Susan 4 pounds 2 pounds Tom 2 pounds 4 pounds •Susan can pick 12 pounds of nuts a day (2 pounds per hour x 6 hours per day) •Tom can pick 24 pounds of nuts a day (4 pounds per hour x 6 hours per day) •Therefore they can gather a total of 36 pounds of nuts a day Solution to Problem 9 (3) c) If Susan and Tom were picking the maximum number of pounds of coffee when they decided they would like to begin gathering 4 pounds of nuts per day, who would gather the nuts, and how many pounds of coffee would they still able to pick? Solution to Problem 9 (4) Coffee / hour Nuts / hour Susan 4 pounds 2 pounds Tom 2 pounds 4 pounds • Susan’s opportunity cost of gathering nuts – 4 pounds of coffee forgone in an hour – Susan’s opportunity cost of gathering nuts is 2 pounds of coffee • Tom’s opportunity cost of gathering nuts – 2 pounds of coffee forgone in an hour – Tom’s opportunity cost of gathering nuts is 0.5 pounds of coffee Solution to Problem 9 (5) Coffee / hour Nuts / hour Susan 4 pounds 2 pounds Tom 2 pounds 4 pounds • Since Tom has a lower opportunity cost of gathering nuts than Susan, Tom should gather nuts, Susan should gather coffee • As they now want to have 4 pounds of nuts and as many pounds of coffee as possible, so Tom will gather 4 pounds of nuts • Tom: - Since it would take Tom only 1 hour to pick 4 pounds of nuts and given the 6 hours working hours, he can still pick coffee in his 5 working hours remaining - In total, Tom will pick 4 pounds of nuts and 10 pounds of coffee • Susan: - She will use all of her working hours on picking coffee - Susan will pick 24 pounds of coffee • As a result, they will end up with 4 pounds of nuts and 34 pounds of coffee a day Solution to Problem 9 (6) d)Now suppose Susan and Tom were gathering the maximum number of pounds of nuts when they decided that they would like to begin picking 8 pounds coffee per day. Who would pick the coffee, and how many pounds of coffee would they still be able to pick Solution to Problem 9 (7) Coffee / hour Nuts / hour Susan 4 pounds 2 pounds Tom 2 pounds 4 pounds • Susan’s opportunity cost of picking coffee – 2 pounds of nuts forgone in an hour – Susan’s opportunity cost of picking coffee is 0.5 pounds of nuts • Tom’s opportunity cost of picking coffee – 4 pounds of nuts forgone in an hour – Tom’s opportunity cost of picking coffee is 2 pounds of nuts Solution to Problem 9 (8) Coffee / hour Nuts / hour Susan 4 pounds 2 pounds Tom 2 pounds 4 pounds • Since Susan has a lower opportunity cost of gathering coffee than Tom, Susan should gather coffee, Tom should gather nuts • As they now want to have 8 pounds of coffee and as many pounds of nuts as possible, so Susan will gather 8 pounds of coffee • Susan: - Since it would take Susan only 2 hour to pick 8 pounds of coffee and given the 6 hours working hours, she can still pick nuts in his 4 working hours remaining - In total, Susan will pick 8 pounds of coffee and 8 pounds of nuts • Tom: - he will use all of his working hours on picking nuts - Tom will pick 24 pounds of nuts • As a result, they will end up with 8 pounds of coffee and 32 pounds of nuts a day Solution to Problem 9 (9) e) Would it be possible for Susan and Tom in total to gather 26 pounds of nuts and pick 20 pounds of coffee each day? If so, how much of each good should each person pick? •This question is an application of Low-hanging fruits principle -In expanding the production of any good, first employ those resources with the lowest opportunity cost, and only afterward turn to resources with higher opportunity costs Solution to Problem 9 (10) Coffee / hour Nuts / hour Susan 4 pounds 2 pounds Tom 2 pounds 4 pounds • Is 26 pounds of nuts and pick 20 pounds of coffee possible? • Susan should specialize in picking coffee and pick nuts in the remaining time -she will spend 5 hours on picking 20 pounds of coffee - then spend the remaining 1 hour on picking nuts, (2 pounds of nuts) • While Tom should specialize in picking nuts and pick coffee if he has any remaining time, -he will spend all 6 hours on picking 24 pounds of nuts • Since Susan has picked 2 pounds of nuts in her remaining time, they can get 26 pounds of nuts in total • This combination is efficient and attainable Chapter 2, Problem 10 (1) Refer to the two-person economy described in the preceding problem. Coffee / hour Nuts / hour Susan 4 pounds 2 pounds Tom 2 pounds 4 pounds a) Is the point (30 pounds of coffee per day, 12 pounds of nuts per day) an attainable point? Is it an efficient point? What about the point (24 pounds of coffee per day, 24 pounds of nuts per day)? Solution to Problem 10 (2) Coffee / hour Nuts / hour Susan 4 pounds 2 pounds Tom 2 pounds 4 pounds - Is 30 pounds of coffee, 12 pounds of nuts attainable? - Susan has comparative advantage on coffee and Tom has comparative advantage on nut. • For Susan: • If she spends 6hr on picking coffee, she will get 24 pounds of coffee • Leaving 6 pounds of coffee for Tom to pick • For Tom: • He should spend 3 hours on picking 12 pounds of nuts • Given the 6 hours of working, Tom is left with 3 hours on picking coffee (6 pounds of coffee) Solution to Problem 10 (3) Coffee / hour Nuts / hour Susan 4 pounds 2 pounds Tom 2 pounds 4 pounds • Therefore, by having Susan spends 6 hrs on picking coffee (24pounds of coffee), and Tom spending 3 hrs on picking coffee (6pounds of coffee) and 3 hrs on picking nuts (12 pounds of nuts), the point 30 pounds of coffee and 12 pounds of nuts is attainable and efficient. Solution to Problem 10 (4) Coffee / hour Nuts / hour Susan 4 pounds 2 pounds Tom 2 pounds 4 pounds a) Is 24 pounds of coffee and 24 pounds of nuts attainable? • For Susan: • Since she has comparative advantage on coffee, so she will spend 6hrs on picking coffee and get 24 pounds of coffee • For Tom: • Since Tom has comparative advantage on nuts, so he will spend 6hrs on picking nuts and get 24 pounds of nuts • Therefore, by having each works full time at his/her activity of comparative advantage, the point 24 pounds of coffee and 24 pounds of nuts is attainable and efficient. Solution to Problem 10 (5) b) On a graph with pounds of coffee per day on the vertical axis and pounds of nuts per day on the horizontal axis, show all the points you identified in Problem 9, parts a-e, and Problem 10a. Connect these points with straight lines. Is the result the PPC for the economy consisting of Susan and Tom? Solution to Problem 10 (6) Coffee / hour Nuts / hour Susan 4 pounds 2 pounds Tom 2 pounds 4 pounds 9a 9c C Production Possibilities Curve • for Susan & Tom 10a 30 9e 26 24 10aA Let’s check pt. B, 8 pounds of coffee, 32 pounds of nuts -Susan picks 8 pounds of coffee in 2 hours, picks 8 pounds of nuts in 4 hours -Tom picks 24 pounds of nuts in 6 hours -Therefore, pt. B is attainable and efficient • Similar for Pt. C • We can conclude that this PPF consists of Tom and Susan 9dB 8 0 If they specialize, they could achieve all the different combinations on the PPF To Check: • Susan specializes on picking coffee, and Tom specializes on picking nuts, (pt. A) Coffee (lb/day) 36 34 • 4 12 20 24 9b 32 36 Nuts (lb/day) Solution to Problem 10 (7) c) Suppose that Susan and Tom could buy or sell coffee and nuts in the world market at a price of $2 per pound for coffee and $2 per pound for nuts. If each specialized completely in the good for which he or she had a comparative advantage, how much could they earn by selling all their produce? Solution to Problem 10 (8) Coffee / hour Nuts / hour Susan 4 pounds 2 pounds Tom 2 pounds 4 pounds • If each specialized completely, they can produce 24 pounds on each good. (the point at which the kink occurs in the PPC diagram). • If they sell in the world market at price $2 each, they will receive a total of $96/day Solution to Problem 10 (9) d) At the prices just described, what is the maximum amount of coffee Susan and Tom could buy in the world market? The maximum amount of nuts? Would it be possible for them to consume 40 pounds of coffee and 8 pounds of nuts each day? • With $96 per day to spend and at the world price of $2 each, -the maximum amount of coffee they can buy is 48 pounds per day of coffee. - the maximum amount of nuts they can buy is 48 pounds per day of nuts. Solution to Problem 10 (10) d) Is it possible to consume 40 pounds of coffee and 8 pounds of nuts? • • • • • • At the world price of $2 each, 40 pounds of Coffee cost $80 8 pounds of Nuts cost $16 Total cost of nuts and coffee is $96 Given the total amount of money they earn by selling all their produce, they have $96 to spend (from 10c) Therefore, they would have just enough money to consume this combination of goods. Solution to Problem 10 (11) e) In light of their ability to buy and sell in world market at the stated prices, show on the same graph all combinations of the two goods it would be possible for them to consume. Solution to Problem 10 (12) Coffee (lb/day 48 E “Consumption Possibilities Curve” G 40 36 -they are also possible to consume, 40 pounds of coffee, 8 pounds of nuts, (pt. G on graph) -they are able to consume more if trading with the world market 24 F 0 - With the ability to buy or sell each good at $2 per pound in world market, - the maximum amount they can consume, 48 pounds of coffee, 48 pounds of nuts, (pt. E and pt. F on graph) 8 24 36 48 Nuts (lb/day -Consumption Possibilities Curve the maximum amount of good participants can consume in international trade End of Chapter 2