Homework (Ch 02)

1. Comparative and absolute advantage

Gilberto and Juanita run a catering business in which they have two major tasks: getting new clients and preparing food for events and parties. It takes Gilberto 10 hours to prepare the food for an event and 5 hours of effort to get each new client. For Juanita, it takes 12 hours to prepare food for an event and 3 hours to get a new client.

In this scenario,Gilberto Correct

has an absolute advantage in food preparation, andGilberto Correct

has a comparative advantage in food preparation.

Points:

1 / 1

A person has an absolute advantage in producing a good when they can produce more of that good than someone else can with the same resources. In this case, Gilberto has an absolute advantage in food preparation because he can do it in less time (10 hours) than Juanita can (12 hours).

A person has a comparative advantage in producing a good when they can produce the good at a lower opportunity cost than someone else can. In this case, Gilberto has a comparative advantage in food preparation because his opportunity cost of preparing food for one more event (2 new clients) is lower than Juanita’s opportunity cost of preparing food for one more event (4 new clients).

Suppose that initially, Gilberto and Juanita are splitting both tasks for a large number of events. Then they decide to start shifting some work according to the principle of comparative advantage. In particular, the person with the comparative advantage in food preparation will take over preparing food for one more event by taking the necessary time away from getting more clients, and the other person will use the freed-up time from not preparing food for one event to get more clients.

As a result, the total number of events for which food is prepared will remain unchanged, but the number of new clients will increase by

Correct

Points:

1 / 1

Recall that Gilberto has a comparative advantage in food preparation. When he takes over preparing food for one event, he has to shift 10 hours away from getting clients. This causes Gilberto to attract 2 fewer clients.

However, by freeing Juanita from having to prepare food for one event, Juanita can shift 12 hours to getting new clients. Because it takes Juanita 3 hours to get a new client, in 12 hours she can get

\frac{12 hours}{3 hours per new client} = 4 new clients

In total, Gilberto gets 2 fewer clients, but Juanita gets 4 more clients. Therefore, new clients increase by

4 - 2 = 2

when Gilberto takes over preparing food for one event that Juanita was previously working.

2. Absolute and comparative advantage

Consider two neighboring island countries, Charisma and Euclidia. Each has 900,000 labor hours available per week that it can use to produce jeans, corn, or a combination of both. The following table shows the amount of labor hours required to produce 1 pair of jeans or 1 bushel of corn.

Country	Jeans	Corn
Country	(Labor hours per pair)	(Labor hours per bushel)
Charisma	40	10
Euclidia	36	6

Euclidia has an absolute advantage in the production of jeans, andEuclidia has an absolute advantage in the production of corn.

Points:

1 / 1

A country has an absolute advantage in the production of a good if it can produce a unit of output using fewer resources than another country. Here, the only resource you are considering is labor.

Charisma needs 40 hours of labor per week to produce a pair of jeans, and Euclidia needs 36 hours of labor per week to produce a pair of jeans. Therefore, Euclidia has an absolute advantage in the production of jeans.

Charisma needs 10 hours of labor per week to produce a bushel of corn, and Euclidia needs 6 hours of labor per week to produce a bushel of corn. Therefore, Euclidia has an absolute advantage in the production of corn.

Initially, suppose Charisma uses 225,000 hours of labor per week to produce jeans and 675,000 hours per week to produce corn, while Euclidia uses 675,000 hours of labor per week to produce jeans and 225,000 hours per week to produce corn. Assume there are no other countries willing to trade goods, so in the absence of trade between these two countries, each country consumes the amount of jeans and corn it produces.

Charisma’s opportunity cost of producing 1 pair of jeans is4 bushels of corn, and Euclidia’s opportunity cost of producing 1 pair of jeans is6 bushels of corn. Therefore,Charisma has a comparative advantage in the production of jeans, andEuclidia has a comparative advantage in the production of corn.

Points:

1 / 1

Charisma can produce 1 pair of jeans using 40 hours of labor, or it can produce 1 bushel of corn using 10 hours of labor. Therefore, the opportunity cost of a pair of jeans is

\frac{40}{10} = 4 bushels per pair

. Euclidia can produce 1 pair of jeans using 36 hours of labor, or it can produce 1 bushel of corn using 6 hours of labor. Therefore, the opportunity cost of a pair of jeans is

\frac{36}{6} = 6 bushels per pair

. Since Charisma has a lower opportunity cost of producing a pair of jeans, it has a comparative advantage in the production of jeans.

Charisma can produce 1 pair of jeans using 40 hours of labor, or it can produce 1 bushel of corn using 10 hours of labor. Therefore, the opportunity cost of a bushel of corn is

\frac{10}{40} = 1/4 pair per bushel

. Euclidia can produce 1 pair of jeans using 36 hours of labor, or it can produce 1 bushel of corn using 6 hours of labor. Therefore, the opportunity cost of a bushel of corn is

\frac{6}{36} = 1/6 pair per bushel

. Since Euclidia has a lower opportunity cost of producing a bushel of corn, it has a comparative advantage in the production of corn.

Another way of looking at this is to consider how much each country could produce if it devoted the entire 900,000 labor hours to producing each good. That is, Charisma would be able to produce either

\frac{900,000}{40} = 22,500

pairs of jeans or

\frac{900,000}{10} = 90,000

bushels of corn. Therefore the opportunity cost of 90,000 bushels of corn is 22,500 pairs of jeans. The opportunity cost of 1 bushel of corn is therefore

\frac{22,500}{90,000} = 1/4 pair per bushel

When neither country specializes, the total production of jeans is

24,375

pairs per week, and the total production of corn is

105,000

bushels per week.

Points:

1 / 1

When neither country specializes, Charisma produces (and consumes)

\frac{225,000 hours}{40 hours per pair} = 5,625 pairs

of jeans and

\frac{675,000 hours}{10 hours per bushel} = 67,500 bushels

of corn per week, and Euclidia produces (and consumes)

\frac{675,000 hours}{36 hours per pair} = 18,750 pairs

of jeans and

\frac{225,000 hours}{6 hours per bushel} = 37,500 bushels

of corn per week. Thus, the total production of jeans is 24,375 pairs, and the total production of corn is 105,000 bushels.

Suppose that Charisma completely specializes in the production of the good in which it has a comparative advantage, producing only that good. It will produce

90,000

bushels of corn . Suppose also that Euclidia does not specialize and uses 225,000 hours of labor to produce jeans and 675,000 hours of labor to produce corn. It will produce

6,250

pairs of jeans and

112,500

bushels of corn.

Points:

0.5 / 1

Because Charisma has a comparative advantage in the production of jeans, this means that if Charisma completely specializes in the production of this good, it produces

\frac{900,000 hours}{40 hours per pair} = 22,500 pairs

of jeans.

If Euclidia uses 225,000 hours of labor to produce jeans and 675,000 hours of labor to produce corn, it produces

\frac{225,000 hours}{36 hours per pair} = 6,250 pairs

of jeans, and it produces

\frac{675,000 hours}{6 hours per bushel} = 112,500 bushels

of corn.

Suppose Charisma and Euclidia agree to trade with each other, exchanging 14,000 pairs of jeans for 70,000 bushels of corn. In particular, Charisma will export the goods it produces, and Euclidia will export the goods that Charisma does not produce.

With trade, Charisma willimport jeans andexport corn. Euclidia willexport jeans andimport corn.

Points:

0 / 1

When Charisma specializes and Euclidia still produces the combination of goods using 225,000 hours of labor to produce jeans and 675,000 hours of labor to produce corn, the total production of jeans becomes

6,250

pairs per week, and the total production of corn becomes

150,000

bushels per week.

Points:

0 / 1

When the countries specialize, Charisma produces 22,500 pairs of jeans per week, and Euclidia produces 6,250 pairs of jeans and 112,500 bushels of corn per week. Therefore, Charisma will export jeans and import corn, and Euclidia will import jeans and export corn. Moreover, total production of jeans will increase from 24,375 to 28,750 pairs of jeans, and the total production of corn will increase from 105,000 to 112,500 bushels of corn due to this specialization and trade.

Notice that with specialization and trade, both countries also consume more of each good than they did initially.

3. Comparative advantage and gains from trade

Consider two neighboring island countries called Bellissima and Euphoria. They each have 4 million labor hours available per month that they can use to produce jeans, corn, or a combination of both. The following table shows the amount of jeans or corn that can be produced using 1 hour of labor.

Country	Jeans	Corn
Country	(Pairs per hour of labor)	(Bushels per hour of labor)
Bellissima	8	16
Euphoria	5	20

Initially, suppose Bellissima uses 1 million hours of labor per month to produce jeans and 3 million hours per month to produce corn, while Euphoria uses 3 million hours of labor per month to produce jeans and 1 million hours per month to produce corn. Consequently, Bellissima produces 8 million pairs of jeans and 48 million bushels of corn, and Euphoria produces 15 million pairs of jeans and 20 million bushels of corn. Assume there are no other countries willing to trade goods, so in the absence of trade between these two countries, each country consumes the amount of jeans and corn it produces.

Bellissima’s opportunity cost of producing 1 pair of jeans is2 bushels of corn, and Euphoria’s opportunity cost of producing 1 pair of jeans is4 bushels of corn. Therefore,Bellissima has a comparative advantage in the production of jeans, andEuphoria has a comparative advantage in the production of corn.

Points:

1 / 1

Using an hour of labor, Bellissima can produce 8 pairs of jeans or 16 bushels of corn. Therefore, the opportunity cost of a pair of jeans is 2 bushels per pair (

\frac{16 bushels}{8 pairs}

). Using an hour of labor, Euphoria can produce 5 pairs of jeans or 20 bushels of corn. Therefore, the opportunity cost of a pair of jeans is 4 bushels per pair (

\frac{20 bushels}{5 pairs}

). Since Bellissima gives up fewer bushels per pair of jeans, it has a comparative advantage in the production of jeans.

You can compute Bellissima’s opportunity cost of a bushel of corn by taking the reciprocal of the opportunity cost of a pair of jeans. That is, the opportunity cost of a bushel of corn, in this case, is 1/2 pair per bushel. Similarly, Euphoria’s opportunity cost of a bushel of corn is equal to 1/4 pair per bushel. Since Euphoria gives up fewer pairs of jeans per bushel of corn, it has a comparative advantage in the production of corn.

Suppose that each country completely specializes in the production of the good in which it has a comparative advantage, producing only that good. In this case, the country that produces jeans will produce

million pairs per month, and the country that produces corn will produce

million bushels per month.

Points:

1 / 1

In the following table, enter each country’s production decision on the third row of the table (labeled “Production”).

	Bellissima		Euphoria
	Jeans	Corn	Jeans	Corn
	(Millions of pairs)	(Millions of bushels)	(Millions of pairs)	(Millions of bushels)
Without Trade
Production	8	48	15	20
Consumption	8	48	15	20
With Trade
Production	32	0	0	80
Imports/Exports	Exports 18	Imports 54	Imports 18	Exports 54
Consumption	14	54	18	26
Gains from Trade
Increase in Consumption	8	6	3	6

Points:

0.94 / 1

Recall that Bellissima has a comparative advantage in the production of jeans and that Euphoria has a comparative advantage in the production of corn. If Bellissima completely specializes in the production of jeans, it produces 32 million pairs of jeans (

4 million hours \times 8 pairs of jeans per hour

). Similarly, if Euphoria completely specializes in the production of corn, it produces 80 million bushels of corn (

4 million hours \times 20 bushels of corn per hour

Suppose the country that produces jeans trades 18 million pairs of jeans to the other country in exchange for 54 million bushels of corn.

In the previous table, use the dropdown menus across the row labeled “Imports/Exports” to select the amount of each good that each country imports and exports. Then enter each country’s final consumption of each good on the line labeled “Consumption.”

When they specialize, Bellissima produces 32 million pairs of jeans per month, and Euphoria produces 80 million bushels of corn per month. If Bellissima trades 18 million pairs of jeans for 54 million bushels of corn from Euphoria, Bellissima will consume 14 million pairs of jeans and 54 million bushels of corn, and Euphoria will consume 18 million pairs of jeans and 26 million bushels of corn.

Note that when a country imports goods, it brings them into the country. In this case, the consumption of that good must be larger than what the country produces itself. Similarly, when a country exports goods, it sends them out of the country. In this case, the consumption of that good must be smaller than what the country produces itself.

When the two countries did not specialize, the total production of jeans was 23 million pairs per month, and the total production of corn was 68 million bushels per month. Because of specialization, the total production of jeans has increased by

million pairs per month, and the total production of corn has increased by

million bushels per month.

Points:

1 / 1

Because the two countries produce more jeans and more corn under specialization, each country is able to gain from trade.

Calculate the gains from trade—that is, the amount by which each country has increased its consumption of each good relative to the first row of the previous table. Enter this difference in the boxes across the last row (labeled “Increase in Consumption”).

Initially, before the two countries specialized, Bellissima produced (and consumed) 8 million pairs of jeans and 48 million bushels of corn per month, and Euphoria produced (and consumed) 15 million pairs of jeans and 20 million bushels of corn per month.

When they specialized, Bellissima produced 32 million pairs of jeans per month, and Euphoria produced 80 million bushels of corn per month. This is an increase of 9 million pairs of jeans and 12 million bushels of corn per month. If Bellissima trades 18 million pairs of jeans for 54 million bushels of corn from Euphoria, both countries will end up consuming more of both goods. In particular, there will be an increase of 6 million pairs of jeans and 6 million bushels of corn for Bellissima and an increase of 3 million pairs of jeans and 6 million bushels of corn for Euphoria.

You can also see how each country gains from trade by using a production possibilities frontier (PPF) diagram. The blue lines on the following diagrams show the PPFs of Bellissima and Euphoria. The black points (plus symbol) show their initial consumption of jeans and corn. The orange points (square symbol) show the amount of jeans and corn each consumes after specialization and trade.

Note that the total gains from trade are 9 million pairs of jeans and 12 million bushels of corn per month, which is the total increase in production you calculated earlier. Visually, you can see that there are gains from trade because countries are able to consume at points that were previously not feasible (that is, points outside of their PPF).

4. Specialization and trade

When a country specializes in the production of a good, this means that it can produce this good at a lower opportunity cost than its trading partner. Because of this comparative advantage, both countries benefit when they specialize and trade with each other.

The following graphs show the production possibilities frontiers (PPFs) for Maldonia and Lamponia. Both countries produce lemons and sugar, each initially (that is, before specialization and trade) producing 24 million pounds of lemons and 12 million pounds of sugar, as indicated by grey points (star symbols) labeled point A.

Maldonia has a comparative advantage in the production ofsugar , while Lamponia has a comparative advantage in the production oflemons . If each fully specializes (that is, produces only the good for which each has a comparative advantage), the most the two countries can produce is

million pounds of sugar and

million pounds of lemons.

Points:

1 / 1

The opportunity cost of a pound of lemons in Maldonia is 3/2 pounds of sugar, whereas the opportunity cost of a pound of lemons in Lamponia is 1/2 pound of sugar. Therefore, Lamponia has a comparative advantage in the production of lemons. (Note: One way to find the opportunity cost of a pound of lemons in Maldonia is to examine how many pounds of lemons Maldonia can produce if it produces only that good and then determine how many pounds of sugar it gives up:

\frac{48 million pounds of sugar}{32 million pounds of lemons} = 3/2 pounds of sugar per pound of lemons

The opportunity cost of a pound of sugar in Maldonia is 2/3 pound of lemons, whereas the opportunity cost of a pound of sugar in Lamponia is 2 pounds of lemons. Therefore, Maldonia has a comparative advantage in the production of sugar.

When the two countries fully specialize according to their comparative advantages, Maldonia will produce 48 million pounds of sugar, and Lamponia will produce 48 million pounds of lemons.

Suppose that Maldonia and Lamponia specialize and open up to international trade, and the terms of trade in the world market are 1 pound of lemons for 1 pound of sugar. That is, Lamponia is willing to sell Maldonia 1 pound of lemons in exchange for 1 pound of sugar, and Maldonia is willing to sell Lamponia 1 pound of sugar in exchange for 1 pound of lemons. The countries decide to exchange 24 million pounds of lemons for 24 million pounds of sugar.

The following graph shows the same PPF for Maldonia as before, as well as its initial consumption at point A. Use the green line (triangle symbol) to plot the trading possibilities line (TPL) for Maldonia. Then place the black point (plus symbol) on the trading possibilities line to indicate Maldonia’s consumption after specialization and trade.

Note: Dashed drop lines will automatically extend to both axes.

Points:

0 / 1

The slope of the trading possibilities line indicates the terms of trade at which the two countries are willing to trade sugar for lemons. In this case, Maldonia and Lamponia agree to trade at a price of 1 pound of lemons for 1 pound of sugar. Given that Maldonia has a comparative advantage in the production of sugar, Maldonia will produce 48 million pounds of sugar and zero pounds of lemons. If it didn’t trade any of its sugar, that combination of sugar and lemons would represent Maldonia’s consumption as well as its production; therefore, that point is one end of its trading possibilities line. On the other hand, if Maldonia traded all of its sugar for lemons, it would end up consuming zero pounds of sugar and 48 million pounds of lemons; therefore, that point is the other end of its trading possibilities line. Note that Maldonia’s trading possibilities line is not dependent on how much Lamponia is willing or able to trade.

Maldonia can then export 24 million pounds of sugar for 24 million pounds of lemons. So, after trade, Maldonia consumes 24 million pounds of lemons as well as 24 million pounds of sugar.

The following graph shows the same PPF for Lamponia as before, as well as its initial consumption at point A.

As you did for Maldonia, use the green line (triangle symbol) to plot the trading possibilities line (TPL) for Lamponia. Then place the black point (plus symbol) on the trading possibilities line to indicate Lamponia’s consumption after specialization and trade.

Points:

0 / 1

The slope of the trading possibilities line indicates the terms of trade at which the two countries are willing to trade sugar for lemons. In this case, Maldonia and Lamponia agree to trade at a price of 1 pound of lemons for 1 pound of sugar. Given that Lamponia has a comparative advantage in the production of lemons, Lamponia will produce 48 million pounds of lemons and zero pounds of sugar. If it didn’t trade any of its lemons, that combination of lemons and sugar would represent Lamponia’s consumption as well as its production; therefore, that point is one end of its trading possibilities line. On the other hand, if Lamponia traded all of its lemons for sugar, it would end up consuming zero pounds of lemons and 48 million pounds of sugar; therefore, that point is the other end of its trading possibilities line. Note that Lamponia’s trading possibilities line is not dependent on how much Maldonia is willing or able to trade.

Lamponia can then export 24 million pounds of lemons for 24 million pounds of sugar. So, after trade, Lamponia consumes 24 million pounds of lemons as well as 24 million pounds of sugar.

True or False: Without engaging in international trade, Maldonia and Lamponia would not have been able to consume at the after-trade consumption bundles. (Hint: Base your answer to this question on the answers you previously entered on this page.)

True

False

Points:

1 / 1

Without engaging in international trade, any quantity outside a country’s original production possibilities frontier (PPF) is considered unattainable. In other words, given an individual country’s resources, the bundles on the PPF are the greatest quantities of the goods that a country can produce (and, therefore, consume) without international trade. By exploiting each country’s comparative advantage to realize gains from trade, Maldonia and Lamponia can consume outside their individual PPFs through specialization.

5. Trading under increasing opportunity costs

The following graph shows the production possibilities frontier for the imaginary country of Contente under conditions of increasing costs. In the absence of trade, the relative cost of wheat in Contente in terms of computers (or the marginal rate of transformation (MRT) of wheat into computers) is shown by the slope of line

t_{1}

, tangent to the production possibilities frontier at point A.

Points:

0 / 1

Which of the following most accurately describes Contente’s economy in the absence of trade?

Contente produces and consumes 6 computers and 120 bushels of wheat.

Contente produces 6 computers and 156 bushels of wheat.

Contente produces 156 bushels of wheat but consumes only 120 bushels of wheat.

Contente consumes 6 computers and 156 bushels of wheat.

Contente produces and consumes 6 computers and 156 bushels of wheat.

Points:

1 / 1

In the absence of trade, Contente is located at point A, which means that it produces and consumes 6 computers and 156 bushels of wheat. Although point C is also feasible, Contente will produce on its production possibilities frontier to utilize all available resources.

At point A, the slope of line

t_{1}

reveals that Contente must forego

bushels of wheat in order to produce 1 computer. (Hint: Select a line to see its slope.)

Points:

1 / 1

The slope of line

t_{1}

, which shows Contente’s marginal rate of transformation (MRT) of wheat into computer, reveals that Contente must forego 4 bushels of wheat in order to produce 1 computer.

Suppose that Contente recognizes that it has a comparative advantage in the production of computers. Contente decides to specialize in making computers and enters international trade. The international terms of trade (the price of wheat in terms of computers) are shown by the slope of the line

t_{2}

, tangent to the production possibilities frontier at point B.

The slope of

t_{2}

reveals that now Contente foregoes

bushels of wheat in order to produce 1 computer. This means that the absolute value of the production possibilities frontier’s slopeincreases .

Points:

1 / 1

The relative cost of computers in terms of wheat rises, as is implied by the increase in the absolute slope of the line tangent to the production possibilities frontier. The slope of line

t_{2}

reveals that now at point B, Contente must forgo 10 bushels of wheat in order to make 1 computer.

Assume that Contente chooses to consume the same number of computers as it did in the absence of trade.

On the previous graph, use the purple point (diamond symbol) to indicate Contente’s consumption after trade.

With specialization and trade, Contente can choose a consumption point along the line

t_{2}

. If Contente chooses to consume 6 computers, as it did before trade, then it can achieve consumption at 6 computers and 180 bushels of wheat.

According to the graph, Contente’s production gain from specialization is

computers , and its consumption gain from trade is

bushels of wheat .

Points:

1 / 1

If Contente specializes in production of computers and enters international trade, it can choose a consumption point along the line

t_{2}

. This means that Contente’s production gain from specialization and trade is

12 computers - 6 computers = 6 computers

, whereas its consumption gain is

180 bushels - 156 bushels = 24 bushels

of wheat.

6. Terms of trade

Suppose that Italy and Switzerland both produce oil and wine. Italy’s opportunity cost of producing a bottle of wine is 4 barrels of oil, while Switzerland’s opportunity cost of producing a bottle of wine is 10 barrels of oil.

By comparing the opportunity cost of producing wine in the two countries, you can tell thatItaly has a comparative advantage in the production of wine, andSwitzerland has a comparative advantage in the production of oil.

Points:

1 / 1

Italy has a lower opportunity cost in the production of wine than Switzerland has; therefore, Italy has a comparative advantage in the production of wine. Specifically, Italy must give up 4 barrels of oil to produce 1 bottle of wine, whereas Switzerland must give up 10 barrels of oil to produce 1 bottle of wine. It is thus less costly for Italy than for Switzerland to produce wine.

You can determine the opportunity cost of oil in terms of wine from the opportunity cost of wine in terms of oil. For example, Italy’s opportunity cost of producing a bottle of wine is 4 barrels of oil. Therefore, Italy can produce 4 barrels of oil if it forgoes the production of 1 bottle of wine, which implies that Italy’s opportunity cost of producing a barrel of oil is 1/4 of a bottle of wine. Similarly, Switzerland’s opportunity cost of producing a bottle of wine is 10 barrels of oil, so Switzerland’s opportunity cost of producing a barrel of oil is 1/10 of a bottle of wine. Because Switzerland has a lower opportunity cost of producing oil than Italy has, it has a comparative advantage in the production of oil.

Suppose that Italy and Switzerland consider trading wine and oil with each other. Italy can gain from specialization and trade as long as it receives more than4 barrels of oil for each bottle of wine it exports to Switzerland. Similarly, Switzerland can gain from trade as long as it receives more than1/10 bottle of wine for each barrel of oil it exports to Italy.

Points:

1 / 1

Italy’s opportunity cost of producing a bottle of wine is 4 barrels of oil. Therefore, if it can import more than 4 barrels of oil for each bottle of wine it exports, it will be better off importing oil than producing it domestically.

Switzerland’s opportunity cost of producing a bottle of wine is 10 barrels of oil. Another way of thinking about this is that for each barrel of oil it produces, it must give up 1/10 of a bottle of wine. Therefore, if it can import more than 1/10 of a bottle of wine for each barrel of oil it exports, it will be better off importing wine than producing wine domestically.

Based on your answers to the previous question, which of the following terms of trade (that is, price of wine in terms of oil) would allow both Switzerland and Italy to gain from trade? Check all that apply.

16 barrels of oil per bottle of wine

2 barrels of oil per bottle of wine

1 barrel of oil per bottle of wine

9 barrels of oil per bottle of wine

Points:

0.25 / 1

Recall that Italy will gain from trade if it gets more than 4 barrels of oil for each bottle of wine it exports. Similarly, Switzerland will trade oil only if it gets more than 1/10 bottle of wine for each barrel of oil it exports. Another way of saying this is that Switzerland is willing to trade up to 10 barrels of oil for each bottle of wine it imports.

Therefore, any price ratio that involves wine selling for between 4 and 10 barrels of oil per bottle of wine will benefit both countries. Any price below 4 barrels of oil per bottle of wine would benefit Switzerland but not Italy; similarly, any price above 10 barrels of oil per bottle of wine would benefit Italy but not Switzerland.

7. Comparative advantage and import competition

Romania joined the European Union (EU) in the early 2000s and began to face intense import competition from other EU members, such as Italy. Suppose you have the following data on labor productivity for footwear and beef production in Romania and Italy. Assume that footwear and beef production are measured in constant dollars reflecting the value of the products.

Use the Ricardian model to analyze possible effects on each country’s footwear and beef industries when answering the questions that follow.

Country	Sales per Employee
	Footwear	Beef
	(Dollars per year)	(Dollars per year)
Romania	39,000	19,500
Italy	78,000	31,200

The table suggests that Italy has an absolute advantage over Romania inboth products and a comparative advantage infootwear .

Points:

1 / 1

A country has an absolute advantage in producing a good when it can produce more of that good than another country can with the same resources. In other words, absolute advantage is an indication of higher productivity. Compared with a worker in Romania, a worker in Italy is

\frac{$78,000}{$39,000} = 2

times more productive in the footwear industry and

\frac{$31,200}{$19,500} = 1.6

times more productive in the beef industry. Thus, Italy has an absolute advantage in both products.

A country has a comparative advantage in producing a good when it can produce the good at a lower opportunity cost than another country. The opportunity cost of footwear in Italy is

\frac{$31,200}{$78,000} = 0.4

. That is, Italy gives up $0.40 worth of beef to gain $1 worth of footwear. The opportunity cost of footwear in Romania is

\frac{$19,500}{$39,000} = 0.5

. That is, Romania gives up $0.50 worth of beef to gain $1 worth of footwear. Since the opportunity cost of footwear in Italy is lower than in Romania, Italy has a comparative advantage in footwear production.

The table suggests that wages in Italy arelower than in Romania.

Points:

0 / 1

Wages are determined by absolute advantage. Romania’s lower productivity relative to Italy (absolute disadvantage) in both industries suggests that wages in Romania are higher than those in Italy.

As a result of Romania’s joining the EU, employment in Romania is likely to fall inthe beef industry .

Points:

0 / 1

The fact that Italy has a comparative advantage in footwear over Romania means that Italy can produce footwear more cheaply and export footwear to Romania at a lower price, undercutting Romanian footwear producers. As a result of this import competition, Romania’s footwear production is likely to decrease, and employment in the footwear industry is likely to fall.

True or False: The degree of openness of the Romanian economy will not influence the mix of jobs.

True

False

Points:

1 / 1

This statement is false. Standard trade theory suggests that the degree of openness of an economy influences the mix of jobs within an economy. This causes dislocation in certain areas or industries when workers and capital shift away from industries in which they are productive (relative to foreign producers) and toward industries they have a comparative advantage in. However, openness has a negligible effect on the overall level of employment. The main determinants of total employment are factors such as the available workforce, the total spending in the economy, and the regulations that govern the labor market.

7. Comparative advantage and import competition

The Czech Republic joined the European Union (EU) in the early 2000s and began to face intense import competition from other EU members, such as France. Suppose you have the following data on labor productivity for apparel and wine production in the Czech Republic and France. Assume that apparel and wine production are measured in constant dollars reflecting the value of the products.

Use the Ricardian model to analyze possible effects on each country’s apparel and wine industries when answering the questions that follow.

Country	Sales per Employee
	Apparel	Wine
	(Dollars per year)	(Dollars per year)
The Czech Republic	50,000	25,000
France	80,000	32,000

The table suggests that France has an absolute advantage over the Czech Republic inboth products and a comparative advantage inapparel .

Points:

1 / 1

\frac{$80,000}{$50,000} = 1.6

times more productive in the apparel industry and

\frac{$32,000}{$25,000} = 1.28

times more productive in the wine industry. Thus, France has an absolute advantage in both products.

A country has a comparative advantage in producing a good when it can produce the good at a lower opportunity cost than another country. The opportunity cost of apparel in France is

\frac{$32,000}{$80,000} = 0.4

. That is, France gives up $0.40 worth of wine to gain $1 worth of apparel. The opportunity cost of apparel in the Czech Republic is

\frac{$25,000}{$50,000} = 0.5

. That is, the Czech Republic gives up $0.50 worth of wine to gain $1 worth of apparel. Since the opportunity cost of apparel in France is lower than in the Czech Republic, France has a comparative advantage in apparel production.

The table suggests that wages in the Czech Republic arelower than in France.

Points:

1 / 1

Wages are determined by absolute advantage. The Czech Republic’s lower productivity relative to France (absolute disadvantage) in both industries suggests that wages in the Czech Republic are lower than those in France.

As a result of the Czech Republic’s joining the EU, employment in the Czech Republic is likely to fall inthe apparel industry .

Points:

1 / 1

The fact that France has a comparative advantage in apparel over the Czech Republic means that France can produce apparel more cheaply and export apparel to the Czech Republic at a lower price, undercutting Czech apparel producers. As a result of this import competition, the Czech Republic’s apparel production is likely to decrease, and employment in the apparel industry is likely to fall.

True or False: The degree of openness of the Czech economy will influence the mix of jobs.

True

False

Points:

1 / 1

This statement is true. Standard trade theory suggests that the degree of openness of an economy influences the mix of jobs within an economy. This causes dislocation in certain areas or industries when workers and capital shift away from industries in which they are productive (relative to foreign producers) and toward industries they have a comparative advantage in. However, openness has a negligible effect on the overall level of employment. The main determinants of total employment are factors such as the available workforce, the total spending in the economy, and the regulations that govern the labor market.

8. Advantages of outsourcing

Indicate whether each scenario in the following table is an example of outsourcing.

Scenario	Outsourcing	Not Outsourcing
A French engineering firm closes its own accounts payable department and hires a Swiss accounting firm to take care of this aspect of its business.
The Google office in the United States contracts an independently operated software engineering company to handle bugs relating to its email service.
Verizon decides to handle all of its customer service operations using its own full-time employees in the United States.

Points:

1 / 1

Outsourcing is the process by which a company takes some of its operations and hires another company or person to perform them rather than doing it themselves.

Which of the following are advantages of outsourcing? Check all that apply.

Allows firms to access advanced talent and skills

Reduces costs for the company that is outsourcing

Creates opportunity for new exports

Points:

0.67 / 1

Although there are obvious benefits of outsourcing to the recipient country, the domestic country can also benefit from outsourcing in several ways:

•

Outsourcing can reduce costs and increase competitiveness for the domestic firm.

•

Outsourcing allows a firm to bring together people with unique talents and capabilities to solve complex problems.

•

The firm in the recipient country may purchase additional goods from the domestic country as business expands, bringing an opportunity for new exports.

9. The logic of service outsourcing – The Ricardian model

It is sometimes argued in editorials or TV commentaries that the modern wave of outsourcing, especially outsourcing of services to Pakistan, defies the logic of the Ricardian model. Let’s examine if this is actually the case.

The following table presents information on labor productivity in computer component production and call center services in Canada and Pakistan. Assume that Canada has an absolute advantage in both.

To complete the following table, choose the number of calls that would be most plausible and consistent with the reality of outsourcing services to Pakistan, and indicate the good in which each country has a comparative advantage.

Country	Production per Employee		Comparative Advantage
	Computer Components	Call Center Services
	(Units per hour)	(Phone calls per hour)
Canada	12	6	Computer component production
Pakistan	2	4	Call center services

Points:

1 / 1

Empirical evidence suggests that labor productivity in manufacturing is much higher in Canada and other developed countries than it is in Pakistan. In service activities, however, Pakistani workers are about as productive as their counterparts in developed countries. In call centers, for example, you can assume that Pakistani employees can handle about the same number of calls per hour as employees in Canada. The only choice to complete the table that accurately reflects these facts is 4 phone calls per hour. Values below or equal to the number of computer parts per hour produced in Pakistan (in this case, 2 parts per hour) do not reflect the relative skills of the Pakistani workforce. At the same time, the value that correctly completes the table must be below the number of calls per hour processed in Canada (6 calls per hour) because of the fact that Canada has an absolute advantage over Pakistan in the production of both goods.

The opportunity cost of a computer component in Canada is

\frac{6 calls}{12 components} = 0.5 calls per component

. In Pakistan, it is

\frac{4 calls}{2 components} = 2.0 calls per component

. Since the opportunity cost of a computer component in Canada is lower than in Pakistan, Canada has a comparative advantage in producing computer components.

The opportunity cost of handling a phone call in Canada is

\frac{12 components}{6 calls} = 2 components per call

. In Pakistan, it is

\frac{2 components}{4 calls} = 0.5 components per call

. (Note: The opportunity cost of a phone call can also be calculated by taking the inverse of the opportunity cost of a computer component.) Since the opportunity cost of a phone call in Pakistan is lower than in Canada, Pakistan has a comparative advantage in handling phone calls.

Does the observed pattern of outsourcing from Canada to Pakistan, where Pakistan exportscall center services Correct

, defy the logic of the Ricardian model?

Yes

Points:

0.5 / 1

The Ricardian model predicts that a country will export the product of its comparative advantage. So, by this logic, it is not surprising that Pakistan exports call center services.

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Homework (Ch 02)

1. Comparative and absolute advantage

2. Absolute and comparative advantage

3. Comparative advantage and gains from trade

4. Specialization and trade

5. Trading under increasing opportunity costs

6. Terms of trade

7. Comparative advantage and import competition

7. Comparative advantage and import competition

8. Advantages of outsourcing

9. The logic of service outsourcing – The Ricardian model

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