International Trade Theory: Production Possibility Frontiers

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ECO2ITR
Assignment
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Table of Contents
Question 1....................................................................................................................................................2
a. Production Possibility curves...........................................................................................................2
b. Absolute advantage :.........................................................................................................................3
c. Opportunity cost:..............................................................................................................................3
d. Comparative Advantage:..................................................................................................................3
Question 2....................................................................................................................................................4
a................................................................................................................................................................4
b...............................................................................................................................................................5
c................................................................................................................................................................5
d...............................................................................................................................................................6
Question 3:...................................................................................................................................................7
a................................................................................................................................................................7
b...............................................................................................................................................................7
c................................................................................................................................................................7
d...............................................................................................................................................................8
Question 4....................................................................................................................................................8
References....................................................................................................................................................9
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Question 1
Given: Products production per day
Hamburger T-shirts
Mike 10 3
Johnson 7 4
a. Production Possibility curves
Fig 1: curve for Johnson's production possibility
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Fig 2: curve for mike's production possibility
b. Absolute advantage :
For Mike and Johnson we have to find out absolute advantage for producing hamburgers and T-
shirts.
According to the concept of absolute advantage a person producing 2 products will enjoy
absolute advantage in a product that is being produced maximum as compared to other person.
So,
1. Johnson enjoys absolute advantage in producing T-shirts as after devoting a full day he can
produce 4 T-shirts compared to 3 T shirts of mike.
2. While, Mike have an absolute advantage in production of hamburgers as compared to
Johnson as he can produce 10 Hamburgers in relation to 7 Hamburgers of Johnson.
c. Opportunity cost:
According to concept of opportunity cost a benefit or value of something that must have to be
given up in order to achieve something else.
In case of Mike and Johnson, say if they have 2 sources of income at the same time. They have
to give up one source in order to get benefit from the other one.
Here we can calculate opportunity cost making T-shirts and Hamburgers for Mike and Johnson:
a. In case of Mike, to produce 3 T-shirts he has to give up on the production of 10 Hamburgers.
So for the production of single T-shirt, Mike has to forego 10/3 Hamburgers.
Therefore, opportunity cost for producing T-shirts is 10/3 pieces of Hamburgers.
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b. For Johnson’s case, he has to give up the production of 7 Hamburgers to produce 4 T-shirts.
So for production of single T-shirt Johnson has to give up 7/4 Hamburgers.
Therefore, opportunity cost for making T-shirts is 7/4 units of Hamburgers in case of
Johnson.
Hence so far, Mike have higher opportunity cost as compared to Johnson for making T-
shirts.
(10/3 units of Hamburgers > 7/4 units of Hamburgers that are sacrificed to produce one
T-shirt)
d. Comparative Advantage:
According to the concept of comparative advantage, a person will have comparative advantage if
he can make a product at a minor cost opportunity in relation to the some other person.
Mike: To produce 10 Hamburgers Mike has to give up production of 3 T-shirts. Opportunity cost
3/10 units of T-shirts per single Hamburger.
Johnson: To produce 7 Hamburgers Johnson has to give up production of 4 T-shirts.
Opportunity cost 4/7 units of T-shirts per single Hamburger.
Mike’s opportunity cost (3/10) < Johnson’s opportunity cost (4/7)
Therefore Mike has a comparative advantage with having lower opportunity cost to
produce Hamburgers.
Question 2
labor / output X Y
H 6 (2400/6=400) 12 (2400/12= 200)
F 4 (1800/4=450) 2 (1800/2=900)
Consider H have 2400 labor units and F have 1800 labor units.
a.
The PPF of economy H can be presented as:
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The PPF of economy F may be presented as:
Autarky equilibrium price ratio:
Autarky for Px / Py of H economy = cost opportunity for X in relation to Y for H economy
= 200/400= 0.5
Autarky for Px / Py of F economy = cost opportunity for X in relation to Y for H
economy = 900/450= 2
The range of “world price equilibrium ratio” should have to be Autarky ratio prices of 2
states.
Therefore
Autarky equilibrium price of state H is ½ and of state F is 2
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0.5 ≤ Px / Py ≤ 2

b.
Feasible world price equilibrium ratios; the range:
½ ≤ Pw ≥ 2
c.
Good exports
Table for cost Opportunity of both states:
 Lesser cost opportunity for state H in the manufacturing of item X in comparison to F. So H will
major in in the manufacture of item H and export the additional to state F.
 Lesser cost opportunity for state F in the manufacturing of item Y in comparison to H. So F will
major in in the manufacture of item F and export the additional to state H.
 So, state H will export item X due to having lesser cost opportunit for item Y.
d.
Yes, trade equalizes the actual return of labor in Home as well as foreign country. Because free trade
will lead to balancing of relative output prices for both states. As, factor and output prices are inter-
related, so relative factor price for labor will also be balanced out after trade for home as well as foreign
country.
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Question 3:
a
An upsurge in amount of capital of home state will move its PPF towards the outside. but that shift
cannot be considered parallel.
b
Supply of item 1 for home country shall move parallel to the right.
c
In case of opening up of trade between two markets, Home state should export item 1 and the foreign
state should export item 2.
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d
Because of specialization as a result of open trade, the marginal productivities of each factor (Land,
Labor, Capital) increases.
Question 4
Multiple choice answers
1. E (free-trade & Pre-trade relative prices are not equal)
2. B (more, higher, mobile).
3. C (Trade may have noteworthy damaging effects on some parts of budget of a country.)
4. C (a curved line; diminishing marginal returns)
5. A (is insignificant in the short run).
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References
Becker, G.S., 2017. Economic theory. Routledge.
Dudley, R.M., 2018. Real analysis and probability. Chapman and Hall/CRC.
Ethier, W.J., 2017. The Relevance of Ricardian Trade Theory for the Political Economy of Trade Policy.
In 200 Years of Ricardian Trade Theory (pp. 185-187). Springer, Cham.
Lim, D.J., 2016. Inverse DEA with frontier changes for new product target setting. European Journal of
Operational Research, 254(2), pp.510-516.
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