Question

Draw a PPF for The Federated States of Econesia (FSE) which can produce 1,000 diamonds if it devotes all resources to diamond production or 4,000 automobiles if it devotes all resources to automobile production. There is an increasing opportunity cost of producing each good.

a) Draw a point “A” on your graph indicating the production of 500 diamonds and 2,000 automobilies.

b) Draw a point “B” on the graph that would be an autarky equilibrium point. Be sure to add all information to help someone else realize that this is an autarky equilibrium point

. c) Draw a point “C” on the graph that lies along the same CIC as point A. Label this CIC0.

d) Now the FSE opens to international trade. Start a new graph for part d) to avoid some clutter; be sure to label point B on your graph. Assume that FSE has a comparative advantage in producing diamonds. Label a point “D” on your graph showing where the country would produce. Show exports and imports on your graph along with a new CIC′ curve for utility after trade.

Answer 1

The given figure depicts the PPF for the country producing diamonds and automobiles.

a) Point A in fig depicts point where 500 diamonds and 2000 automobiles are produced in the economy.

b) Autarky equilibrium is that level of equilibrium attained by an economy as the highest level of utility in absence of any trade.

Point B thus in the figure depicts such an equilibrium point where the isovalue line is tangent the PPF.

c) Point C in the graph is on the same CIC as that of point A.

d)In the figure given below. It depicts the situation where the economy has comparative advantage in producing diamonds.

The country would produce at point D. However, the demand would be just Q_D' and hence since demand is less than supply, the country would export diamonds which is depicted in the graph. Since it does not have advantage in producing automobiles, it will import automobile from other countries as shown in the figure.