Q/A

1/1. Explain why neighboring countries tend to trade extensively with each other.
>The most obvious answer is transportation costs, both in money and in time. A firm will buy
components from the closer supplier rather than one farther away (given the same quality of
product) because transportation will likely be faster and less expensive. For
example, U.S. automobile manufacturers buy more parts from Canada than from Germany.
Also, individuals in countries that share borders are probably more familiar with each other’s
business practices and customs, resulting in lower transactions costs.
2/1.Suppose that the economy produces three goods—raisins (R), soybeans (S), and
textiles (T). What would its PPF look like under conditions of constant opportunity costs?
What would it look like with increasing opportunity costs?
>With three goods, we have a three dimensional figure with three axes, R, S and T. With
constant opportunity costs, the PPF is a plane instead of a line.
Again, three goods requires a three dimensional picture with three axes. But in the case of
increasing opportunity costs, the figure will look like a hemisphere rather than the plane above.
/2 nominal real

a 115 115 Real GDP is constant in cases a and b. because real output is the
same in the two cases—only the prices have changed. Since the
b 230 115
prices doubled, we would expect nominal GDP to double as well.
c 256 32

d 384 48

/5 Suppose that in world markets the relative price of S is lower

than country A’s autarky price. Would A be a net exporter or
importer of S? What would be the case for good T in country
A-in-this-situation?
this is exactly the situation discussed in the previous question. If the world’s relative price
of S is lower than A’s autarky price, the relative price line will be flatter and a corner solution
would occur. Which corner? If producers completely specialized in S, they would actually be
minimizing their income. They would maximize their income by only producing T.

3/1 For each of the following cases below determine the following:
a.the pre-trade relative prices
b.the direction of comparative advantage
Step-By-Step Solution

1. Case 1:
a.in country A, PS/PT = 6/2 = 3
in country B, PS/PT = 15/12 = 5/4
b.country A has comparative advantage in T
country B has comparative advantage in S

Case 2:
a.in country A, PS/PT = 10/4 = 2.5
in country B, PS/PT = 5/5 = 1
b.country A has comparative advantage in T
country B has comparative advantage in S

Case 3:
a.in country A, PS/PT = 1/2
in country B, PS/PT = 2
b.country A has comparative advantage in S
country B has comparative advantage in T

Case 4:
a.in country A, PS/PT = 2
in country B, PS/PT = 3
b.country A has comparative advantage in S
country B has comparative advantage in T