Question

Consider two small countries. One is industrialized with a highly skilled workforce and lots of capital. The other is still developing, with a low educational attainment and little capital. Suppose there are two goods produced in these two countries: grain and textiles. Let’s suppose the industrialized and the developing countries can produce the following units of grain and textiles per year: Industrialized (Ind) Developing (Dev) Grain 800 700 Textiles 600 100 NOTE: Here the abilities are given per year and you are graphing them per year. This is different from the example in the video where the abilities were given per hour and we graphed them per day (so multiplied by 6). Here you do not need to multiply by anything. Also, we can do the same analysis we did with the two households in the example with the two countries in this question. As you can see, the industrialized city can produce more grain and more textiles than the developing one. This is due to better technology and superior productivity level of its workforce. a. What is Ind’s opportunity cost for bushel of grain in terms of textiles? What is Ind’s opportunity cost for a unit of textiles in terms of grain? What is Dev’s opportunity cost for a bushel of grain in terms of textiles? What is Dev’s opportunity cost for a unit of textiles in terms of grain? b. Which city has the absolute advantage in grain? Which city has the absolute advantage in textiles? Which city has the comparative advantage in grain? Which city has the comparative advantage in textiles? c. Putting grain on the vertical axis and textiles on the horizontal axis, draw the PPF for the combined economy if there is no specialization. Remember, this means they are dividing up their time in the same way. Discuss the horizontal and vertical intercepts and the slope. d. On the same graph, draw the PPF for the combined economy if the two countries do specialize and trade – that is to say, they can divide up their time differently. Discuss the horizontal and vertical intercepts, any kink points, and the slope(s). e. Discuss how specialization and trade impact the economy? Who benefits from trade? Who loses?

Answer 1

Country /Goods	Grains	Textiles
Industrialized (Ind)	800	600
Developing (Dev)	700	100

                           

a) Opportunity cost of any good (say good 1) is the units of other goods (say good 2) forgone that could have been produced with the given resources. So for example, United states currently grows 1 million Christmas trees during Christmas and the resources used to produces those trees could have been used to produce 10 million Santa caps. Thus the opportunity cost of 1 million Christmas trees is the loss in terms of the 10 million Santa caps.

a) Solving for different opportunity cost of the two countries :

· Using all its resources Ind can produce either 800 Bushels of Grains or 600 units of textiles

· Using all its resources Dev can produce either 700 Bushels of Grains or 100 Units if textiles

o Ind’s opportunity cost for a bushel of grain in terms of textiles:

800 Bushels of Grain = 600 Units of Textiles

1 Bushel = 600 / 800 units of Grains

1 Bushel = 0.75 unit of grains      

o Ind’s opportunity cost for a unit of textiles in terms of grain:

600 units of textiles = 800 bushel of grains

1 unit if textiles = 800/600 bushel of grain

1 unit of textiles = 1.33

o Dev’s opportunity cost for a bushel of grain in terms of textiles:

700 Bushel of grains = 100 Units of textiles

1 Bushel of grains = 100/700 units if textiles

1 bushel of grains = 0.14 units of textiles

o Dev’s opportunity cost for a unit of textiles in terms of grain:

100 Units of textiles = 700 bushels of grains

1 unit of textiles = 700/100 bushel of grains

1 unit of textiles = 7 bushels of grains

b)

o Absolute Advantage: If a country (Say A) produces more of a specific good than the other country (Say B) with the given amount of resources, then that country (which is A in our case) has an absolute advantage in that good. In the given question, since country Ind produces more of both the goods as compared to country Dev, therefore Ind has an absolute advantage in producing grains as well as textiles.

o Comparative Advantage: A country is said to have a comparative advantage in producing a particular good, if its opportunity cost of producing that good is lower than the other country’s opportunity cost of producing the same good.

o Dev’s opportunity cost for a bushel of grain in terms of textiles is less than Ind’s opportunity cost for a bushel of grain in terms of textiles ( 0.14 < 0.75). Therefore, Dev has a comparative advantage in producing grains.                                                                        

o Ind’s opportunity cost for a unit of textiles in terms of grain is less than Dev’s opportunity cost for a unit of textiles in terms of grains (1.33 < 7). Therefore, Ind has a comparative advantage in producing textiles.