Question

1. Assume two countries (Canada & Britain) each produce wheat and cloth. Given the following details with respect to resources required to produce each good in each country, answer the following questions.

Country	Production (1 Hour of Labor Time)
	Cloth	Wheat
Britain	6	3
Canada	3	1

1. What is the opportunity cost of producing each good in each country? (4 Points)

2. Draw the Production Possibilities Frontier for each country assuming no trade and 500,000 labor hours.

3. Provide an interpretation of the slope of the PPF in this example.

4. If these countries engaged in international trade, in what range would the relative prices have to be to ensure mutually beneficial trade, and which good would each country specialize in?

5. Assuming the relative price with the trade of wheat is 2.5 cloth and the relative price of cloth is .4 wheat, calculate the gains from trade and show on the PPFs the expanded consumption choices for each country.

Answer 1

In the above questions the production of cloth and wheat by each country with the help of 1 labour hour has been given. From the table we can say by using 1 hour labour time Britain can produce 6 clothes or 3 wheats. So for 1 cloth Britain sacrifices or its opportunity cost is 3/6 = 0.5 wheat. On the other hand Canada can produce 3 clothes or 1 wheat by that 1 hour labour time. Now for 1 cloth Canada will sacrifice or Canada's opportunity cost is 1/3 = 0.33 wheat. In terms wheat sacrifice we get Britain sacrifices more (0.5 wheat) than Canada (0.33 wheat) to produce 1 cloth. So, Britain's opportunity cost is more (as 0.5>0.33) to produce 1 cloth.

Similarly we can calculate for 1 wheat Britain sacrifices 6/3 = 2 clothes i.e Britain's opportunity cost is 2 clothes for 1 wheat and Canada sacrifices 3/1 = 3 clothes i.e Canada's opportunity cost is 3 clothes . Therefore Britain sacrifice less(2 clothes) than Canada (3 clothes) to produce 1 wheat. In terms of opportunity cost we can say that Britain has less opportunity cost in wheat production and Canada has less opportunity cost in cloth production.

If there availability of labour hours is 500,000 then the cloth production by Britain is 500,000/6 = 83,333.3333 and wheat by Britain is 500,000/3 = 166,666.6666. Similarly Canada can produce 500,000/3 = 166,666.6666 clothes and 500,000/1 = 500,000 wheats.

Country	Cloth	Wheat
Britain	83,333.33	166,666.66
Canada	166,666.66	500,000

In the following graph we have shown the PPF of Britain and Canada.

The slope of PPF of Britain is - 83,333.33/166,666.66 = 0.5 and slope of PPF of Canada is -166666.66/500,000 = 0.333. Therefore slope of PPF of Britain is more compare to Canada.

In specialisation Britain will produce wheat and Canada will produce cloth and they both will produce 166666.66 and their terms of trade will be 1 wheat for 1 cloth. The range of relative price will be more than 0.5 and if they traded 1 cloth = 1 wheat to they will gain from here.