In an hour, Alex can produce 50 pies or 400 cakes, and David can produce 150 pies or 300 cakes.

a) If Alex and David spend 30 minutes of each hour producing pies and 30 minutes producing cakes, how many pies and cakes does each of them produce?

b) Determine who has a comparative advantage in producing pies, and in producing cakes using opportunity cost? Show your workings.

c) If Alex and David specialise and trade, what is the highest price of a pie at which Alex and David would agree to trade pies and cakes?

d) Determine the gains from trade?

Solutions

Expert Solution

a) Alex will produce 25 pies and 200 cakes. David will produce 75 pies and 150 cakes.The total number produced is 100 pies and 350 cakes each working 30 minutes for cakes and 30 minutes for pies.

b) If Alex spends an hour baking pies,he gains 50 pies but forgoes 400 cakes.Alex's opportunity cost of 1 pie is 400/50 = 8 cakes per pie.

If David spends an hour baking pies,he gains 150 pies but forgoes 300 cakes.David's opportunity cost of 1 pie is 300/150 = 2 cakes per pie.

David has the comparative advantage in producing pies because his opportunity cost of a pie is less than Alex's opportunity cost.Alex has the comparative advantage in producing cakes because his opportunity cost of a cake 1/8 is less than David's opportunity cost 1/2 of a pie.

c)Alex will specialise in cakes and David will specialise in pies.

If they specialize and trade,the total production of both cakes and pies will increase.When each spends 30 minutes making cakes and 30 minutes making pies,together they produce 350 cakes and 100 pies.

When they specialise,together they produce 400 cakes and 150 pies

Alex will trade 25 cakes to David for in exchange for 25 pies.

d)The gains from trade is 150-100=50 pies

and 400-350 =50 cakes.

Rahul Sunny answered 2 years ago

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