Question

1. Imagine that two countries, A and B, can produce just two goods, widgets and somethings. Assume that for a given amount of land and capital, the output of these two products requires the following constant amounts of labour:

Production	Country A Labour	Country B Labour
1 of Widget	4	5
60 of Something	5	10

            Assume that each country has 30 million workers.

(i)        If there is no trade, and in each country 20 million workers produce widgets and 10 million workers produce something, how many widgets and how many something will each country produce? What will be the total production of each product?

(ii)       What is the opportunity cost of a widget in: (i) Country A; (ii) Country B?

(iii)      What is the opportunity cost of 60 something in: (i) Country A; (ii) Country B

(iv)      Which country has a comparative advantage in which product?

(v)       Explain the principle of increasing opportunity cost and does this example illustrate the principle of increasing opportunity cost.

(vi)      What change might shift both countries production possibilities frontier outwards.

Answer 1

a.) Let "60 something" be termed as S for simplification

COUNTRY A

1 unit of widget in Country A requires 4 units of labour. In other words, 1 labor in country A can produce 1/4 widget or 1/5 of S. So, 20 million workers will produce = (1/4)* 20 million widgets = 5 million widgets.

10 million workers will produce (1/5)*10 = 2 million S

COUNTRY B

1 units of labour in Country B can produce either 1/5 widgets or 1/10 S

So, 20 million workers will produce = (1/5)* 20 million widgets = 4 million widgets.

10 million workers will produce (1/10)*10 = 1 million S

Total widgets prodcued = 5+4 = 9 million

Total S produced = 2+1 = 3 million

b) Opportunity cost of widget in country A = 4/5 S

Opportunity cost of widget in country B = 5/10 S

c) Opportunity cost of S in country A = 5/4 widgets

Opportunity cost of S in country B = 10/5 widgets

d) The country which has a lower opportunity cost has a comparative advantage in that product. So, country A has comparative advantage in the production of S and country B has the comparative advantage in the production of widgets.

e) Principle of increasing opportunity cost means that as more and more number of widgets are produced, you need to sacrifice more amount of S in order to produce an additional unit of widget.

The example shows constant opportunity cost because no matter how many widgets you produce, producing one more widget would require sacrifice of 4/5 S in country A and 5/10 S in country B.

f) Increase in the number of workers would lead to an outwards shift in the PPF.

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