Production per month. 250 arrows or 250 bows. a. What is the opportunity cost of producing one arrow in Shtark? Tzargaryen?

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1 ECNS 251 Homework 2 Comparative Advantage & Trade Supply & Demand I Country Shtark Tzargaryen Production per month 200 arrows or 600 bows 250 arrows or 250 bows 1. The table above shows the production possibilities for two countries, Shtark and Tzargaryen, which produce bows and arrows. For simplicity, assume constant opportunity costs. a. What is the opportunity cost of producing one arrow in Shtark? Tzargaryen? Shtark: 200A = 600B, 1B = 1/3 A, 1A = 3B. Every arrow costs 3 bows. Every bow costs 1/3 an arrow Tzargaryen: 250A = 250B, 1 bow costs 1 arrow b. Which country has absolute advantage in producing arrows? Bows? Shtark has absolute advantage in bow production and Tzargaryen has absolute advantage in arrow production. c. Which country has comparative advantage in producing arrows? Bows? Shtark has comparative advantage in bow production because their opportunity cost of bows (1/3 an arrow) is lower than Tzargaryen's opportunity cost of bows (1 arrow). Tzargaryen has comparative advantage in arrow production because their opportunity cost of arrows (1 bow) is lower than Shtark's (3 bows). d. Which of the following trades would be possible and would make both countries better off?

2 i. Shtark trades away 200 bows for 50 arrows from Tzargaryen ii. Shtark trades away 50 bows for 75 arrows from Tzargaryen iii. Shtark trades away 125 bows for 50 arrows from Tzargaryen iv. Shtark trades away 125 arrows for 75 bows from Tzargaryen Shtark is willing to trade up to 3 bows to get one 1 arrow from Tzargaryen (trading any more bows per arrow would make it cheaper for Shtark to produce arrows themselves). Tzargaryen is willing to sell each arrow for a minimum of 1 bow (selling an arrow to Shtark for less than one bow would make Tzargaryen worse off than if they had produced the bow themselves). Therefore the terms of trade will range will be between 1 to 3 bows for each arrow. 2. American and Taiwanese workers can each produce 8 cars a year. An American worker can produce 20 tons of grain a year, whereas a Taiwanese worker can produce 10 tons of grain a year. To keep things simple, assume that each country has 100 million workers. a. For the United States, what is the opportunity cost of a car? Of grain? For Taiwan, what is the opportunity cost of a car? Of grain? U.S.: 8C = 20G, 1C = 20/8C. Each car costs 2.5 tons of grain U.S.: 1C = 2.5G, 1G =.4C. Each ton of grain costs.4 cars Taiwan: 8C = 10G, 1C =1.25G. Each car costs 1.25 tons of grain Taiwan: 1G =.8C Each ton of grain costs.8 cars b. Which country has absolute advantage in producing cars? In producing grain? Neither country has absolute advantage in producing cars. The U.S has absolute advantage in producing grain. c. Which country has comparative advantage in producing cars? In producing grain? The U.S. has comparative advantage in producing grain (because they have a lower opportunity cost of producing grain that Taiwan). Taiwan has comparative advantage in producing cars.

3 d. Suppose that without trade, half of each country s workers produce cars and half produce grain. What quantities of cars and grain does each country produce per year? U.S: 4 (100M) cars & 10 (100M) tons of grain Taiwan: 4 (100M) cars & 5 (100M) tons of grain e. Starting from a position without trade, give an example in which trade makes each country better off. Illustrate this using PFF diagrams for each country. The US has comparative advantage in producing grain, so it will sell grain to Taiwan in exchange for cars. Given its opportunity cost of grain (.4C), the US will need to get at least.4c per ton of grain in order to be better off. Given its opportunity cost, Taiwan will want to buy each ton of grain for a maximum of.8c. Thus, the terms of trade will require 1 ton of grain to sell for between.4 and.8 C. The graph below assumes that each ton of grain sells for.6c, and that the US retains half of its grain produced. So the US trades 10 (100M) tons of grain for 6 (100M) cars. US Taiwan Cars/Year (100M) Cars/Year (100M) Tons of Grain/Year (100M) Tons of Grain/Year (100M)

4 3. In the country of Myrontopia, there are two office supply companies, Dumber Mifflen and Mikel Scoot Paper Co. At Dumber Mifflen, it takes two workers to produce 30 reams of paper per hour and it takes three workers to produce 30 bobbleheads per hour. At Mikel Scoot Paper Co., it takes one worker to produce 20 reams of paper per hour and it takes two workers to produce 10 bobbleheads per hour. a. What is the price of bobbleheads (in terms of paper) for Dumber Mifflen? What is the price of a bobbleheads for Mikel Scoot Paper Co.? Dumber Mifflen 2W = 30R and 3W = 30B 1W = 15R and 1W = 10B 15R = 10B 1B = 1.5R Mikel Scoot Paper Co 1W = 20R and 2W = 10B 1W = 20R and 1W = 5B 20R = 5B 1B = 4R b. Which company has an absolute advantage in the production of each item? Which company has a comparative advantage in the production of each item? Dumber Mifflen has absolute advantage in bobbleheads since with the same resources (1 worker) it can produce more bobbleheads than Mikel Scoot Paper Co. Mikel Scoot Paper Co. has absolute advantage in paper since with the same resources (1 worker) it can produce more paper than Dumber Mifflen. Dumber Mifflen has comparative advantage in bobbleheads since each bobblehead costs fewer resources at Dumber Mifflen (0.1W or 1.5R) than at Mikel Scoot Paper Co. Mikel Scoot Paper Co. has comparative advantage in paper since each ream of paper costs fewer resources at Mikel Scoot Paper Co. (0.05 W or 0.25 B) than at Dumber Mifflen. c. If the companies trade with each other, which item will each trade? Dumber Mifflen will trade bobble heads Mikel Scoot Paper Co. will trade reams of paper

5 d. What is the range of prices at which trade can occur? Dumber Mifflen needs at least 1.5 reams of paper for each 1 bobblehead. Mikel Scoot Paper Co.wants to obtain each bobblehead for a maximum of 4 reams of paper. Therefore 1 bobblehead will trade for between 1.5 and 4 reams of paper. 4. Are the following statements true or false? Explain in each case. a. Two countries can achieve gains from trade even if one of the countries has an absolute advantage in the production of all goods. True. If both countries specialize in their comparative advantage and trade for the other good at a price that is lower than their opportunity cost to produce the other good there will be gains from trade. b. Certain very talented people have a comparative advantage in everything they do. False. People can be very talented but still not have comparative advantage in everything they do. In fact, those with talent are likely to have comparative advantage in their talent/skill area but not in another area. For example, if a high-priced lawyer is very talented at winning jury trials, it is unlikely that they also have comparative advantage in house cleaning or dog walking relative to someone they could hire to do these tasks since an hour spent cleaning the house means an hour less that the lawyer can bill to the trial client. This statement is confusing the concepts of absolute vs. comparative advantage. c. If a certain trade is good for one person, it can t be good for the other one. False. So long as the trade is voluntary, both parties will be at least as well off after the trade as they were before the trade. Trade is not a zero-sum game. d. If a certain trade is good for one person, it is always good for the other one. Technically False but generally True. So long as the trade is voluntary, both parties will be at least as well off after the trade as they were before the trade. This does not necessarily mean that both parties are better off, just that neither party is worse off.

6 e. If trade is good for a country, it must be good for everyone in the country. False. Even though trade may make a country as a whole better off via the compensation principle, producers of a good for which they do not have comparative advantage will be outcompeted by producers in a different country. 5. Consider the markets for staples, staplers, and paper clips. For each pair of goods listed below, identify whether the goods are complements or substitutes for consumers and use a graph of the second good s market to demonstrate graphically how an increase in the price of the first good listed will affect the market for the second good listed. a. Staples and staplers If Pstaples increases, the demand for staplers decreases because they are complements b. Staples and paper clips If Pstaples increases, the demand for paper clips increases because they are substitutes

7 c. Staplers and paper clips If Pstaplers increases, the demand for paper clips increases because they are substitutes 6. Suppose a technological advance reduces the cost of manufacturing staplers. Draw a diagram to show what happens in the market for staplers. Explain the changes in equilibrium price and quantity that occur. Supply curve shifts right due to a change in technology. Equilibrium price decreases and equilibrium quantity increases. 7. A survey shows an increase in viewership for Game of Thrones among young people. When discussing this in your weekly Game of Thrones Fanclub meeting, the two explanations below are proposed. Use supply-and-demand diagrams to show how each of these hypotheses could lead to an increase in viewers of Game of Thrones, and explain your diagrams. How could information on what has happened to the price of Game of Thrones help us to distinguish between these explanations?

8 a. There has been an increase in the number of websites streaming Game of Thrones. This change would increase the supply of Game of Thrones and shift its supply curve right. b. Due to budgetary cutbacks from fighting a lengthy court cases, Commissioner Dodger Badell has cancelled Sunday Night Football, which aired at the same time as Game of Thrones and was also popular among young people. Since Sunday Night Football was a substitute to Game of Thrones, eliminating it (effectively raising its price to infinity) generates an increase in demand for Game of Thrones. If the price of viewing Game of Thrones increases, the dominant shift must have come from the change in demand. If the price of Game of Thrones decreases, the dominant shift must have come from the change in supply.

9 8. Suppose that the price of New England Patriots football game tickets is determined by market forces. Currently, the demand and supply schedules are as follows: Price ($ per ticket) Quantity Demanded (tickets per game) ,000 80, ,000 80, ,000 80, ,000 80, ,000 80,000 Quantity Supplied (tickets per game) a. Draw the demand and supply curves. What is unusual about this supply curve? Why might this be true? The supply curve is a straight vertical line because there are only 80,000 seats available at every game. b. What is the equation for the demand curve (in the form of Qd = f(p))? The supply curve? Demand Curve: Qd=120, P Supply Curve: Qs=80,000

10 c. What are the equilibrium price and quantity of tickets? Qd=120, P = Qs=80, , P = 80, P = 40,000 P = 80 Q = 80,000 d. Due to immigration, 5,000 people move to New England. The new citizens have the demand schedule below. Add the old demand schedule and the new citizens demand schedule to find the new combined total demand schedule for the entire region. What is the equation for the new demand curve (in the form of Qd = f(p))? Price ($ per ticket) Quantity Demanded (tickets per game) 40 5, , , , ,000 The new demand schedule is: Price ($ per ticket) Quantity Demanded (tickets per game) , , , , ,000 So the new demand equation is: Qd ' =126, P

11 e. What will be the new equilibrium price and quantity? 126, P = 80, P = 46,000 P = $87.62 Q = 80,000

12 9. Market research has revealed the following information about the market for chocolate bars: The demand schedule can be represented by the equation Q D = 1, P, where Q D is the quantity demanded per period and P is the price. The supply schedule can be represented by the equation Q S = 1, P, where Q S is the quantity supplied per period. a. Calculate the equilibrium price and quantity in the market for chocolate bars. Q D = Q S 1, P=1, P 200=1000P 200/1000=P P=$.20 Plug this back into one of the Q D or Q S equations 1, (.2)= Q D Quantity=1540/period b. Suppose that chocolate is a normal good. Suppose also that chocolate consumers' incomes increase such that the quantity demanded of chocolate changes by 400 at each price. Compute the new equilibrium price and quantity for chocolate. The new demand equation is simply the old one but add 400 to the intercept term. Set Q D = Q S 2, P=1, P 600=1000P 600/1000=P P=$.60 Plug this back into one of the Q D or Q S equations 2, (.6)= Q D Quantity=1820

13 c. Starting from the initial demand and supply, suppose that an increase in the cost of cocoa (an input in chocolate) causes the quantity supplied to change by 500 at each price. Compute the new equilibrium price and quantity of chocolate. The new supply equation is simply the old one, but subtract 500 from the intercept term. Set Q D = Q S 1, P= P 700=1000P P=$.70 Plug this back into the Q D or Q S equations 1, (.7)= Q D Quantity= Read, "Blue-collar wages are surging. Can it last?" (The Economist, 11/14/2017) and answer the following: a. What impact would wages and salaries rising by 8.7% while prices increased by 9.5% have on the demand for normal goods and services? Inferior goods and services? Why? b. Which kind of shift (demand or supply or both) could explain the result that, "as unemployment has fallen from over 6$ in mid-2014 to just 4.1% today, wage growth has gradually picked up"? Explain your answer. c. The author notes that, "Whether male participation improves may depend on whether men are prepared to up sticks and move to where the labour market is booming." What impact would this kind of labor mobility have on wages in Texas and Oklahoma? On home prices in these areas?