CHAPTER 3: INTERDEPENDENCE AND THE GAIN FROM TRADE

1. Maria can read 20 pages of economics in an hour. She can also read 50 pages of
sociology in an hour. She spends 5 hours per day studying.
a. Draw Maria’s PPF for reading economics and sociology
If Maria spends all 5 hours studying economics, she can read 100 pages, so that is the
vertical intercept of the production possibilities frontier. If she spends all 5 hours
studying sociology, she can read 250 pages, so that is the horizontal intercept. The
opportunity costs are constant, so the production possibilities frontier is a straight line.

b. What is Maria’s opportunity cost of reading 100 pages of sociology?

It takes Maria 2 hours to read 100 pages of sociology. In that time, she could read 40
pages of economics. So the opportunity cost of 100 pages of sociology is 40 pages of
economics.

2. Suppose that there are 10 million workers in Canada and that each of these
workers can produce either 2 cars or 30 bushels of wheat in a year.
a. What is the opportunity cost of producing a car in Canada? What is the opportunity
cost of producing bushel of wheat in Canada? Explain the relationship between the
opportunity costs of the two goods.
- Opportunity cost of producing a car is 15 bushels of wheat
- Opportunity cost of producing a bushel of wheat is 1/15 cars
b. Draw Canada’s PPF. If Canada chooses to consume 10 million cars, how much wheat
can it consume without trade? Label this point on the PPF.
- The maximum amount of car can produce is 20 million cars (10 million worker * 2 cars
per each worker)
- The maximum amount of wheat can produce is 300 million bushels of wheat (10
million workers * 30 bushels of wheat per each worker)
- If Canada chooses to consume 10 million cars without trade, it needs to have 5 million
workers in producing 10 million car, and leaves 5 million workers to product wheat and
producing 150 million bushels of wheat. This can be show in point A, which lie on the
PPF because the production is efficient and obtainable.
c. Now suppose that US offers to buy 10 million cars from Canada I exchange for 20
bushels of wheat per car. If Canada continues to consume 10 million cars, how much
wheat deal allow Canada to consume? Lable this point on your Diagram. Should
Canada accept the deal?
3. England and Scotland both produce scones and sweaters. Suppose that an English
worker can produce 50 scones per hour or 1 sweater per hour. Suppose that a
Scottish worker can produce 40 scones per hour or 2 sweaters per hour.
a. Which country has the absolute advantage in the production of each good? Which
country has the comparative advantage?
- Absolut advantage:
 Because English workers can produce 50 scones per hour which is 10 more than
Scottish workers who can produce 40 scones an hour, they have an absolute
advantage in producing scones.
 Because Scottish workers can produce 2 sweaters compared with English workers
who can only produce 1, they have an absolute advantage.
- Comparative advantage:
 This we have to see what the opportunity cost of producing a good. The
opportunity cost of an English worker producing a sweater is 50 scones. This is
because if they spend an hour producing a sweater, they could have been
producing 50 scones.
 The opportunity cost of a Scottish worker producing a sweater is 20 scones. This
is because in an hour they can produce 2 sweaters or 40 scones. Therefore, for
each sweater they lose 20 scones.
 This means that Scottish workers have a comparative advantage in Sweaters and
English workers have a comparative advantage in Scones.
b. If England and Scotland decide to trade, which commodity will Scotland export to
England?
Because Scotland has a comparative advantage in producing sweaters, Scottland will
export sweaters to England and import scones, of which England has comparative
advantage.
c. If a Scottish worker could produce only 1 sweater per hour, would Scotland still gain
from trade? Would England still gain from trade?
Even if a Scottish worker produced just one sweater per hour, the countries would still
gain from trade, because Scotland would still have a comparative advantage in producing
sweaters. Its opportunity cost for sweaters would be higher than before (40 scones per
sweater, instead of 20 scones per sweater before). But there are still gains from trade
since England has a higher opportunity cost (50 scones per sweater).
4. A German worker takes 400 hours to produce a car and 2 hours to produce a case
of wine. A French worker takes 600 hours to produce a car and X hours to produce
a case of wine.
Germany: 1 car = 200 cases of wine, 1 case of wine = 1/200 car France: 1 car = 600/X
cases of wine, 1 case of wine = x/600 car
a. For what value of X will gains from trade be possible? Explain.
Gains from trade will be possible when X does not equal 3. When X=3, the opportunity
cost of 1 car in France is 200 cases of wine, neither country has a comparative advantage.
At all other values of X, a comparative advantage will exist
b. For what value of X will Germany export cars and import wine? Explain
Germany will export cars and import wine for all values of X less than 3. When X is less
than 3, Germany has comparative advantage in producing car, and France has
comparative advantage in producing wine. Therefore, Germany exports cars and imports
wine.