Answer to the Question from Chapter 22

Answer to the Question from Chapter 22 (1) a. A week's worth of British labor can produce 8 yards of cloth or 2 barrels of wine. This implies that each barrel of wine costs 4 yards of cloth in England. b. A week's worth of Portuguese labor can produce 12 yards of cloth or 6 barrels of wine. This implies that each barrel of wine costs 2 yards of cloth in Portugal. c. The diagram below represents the PPF for Britain and Portugal assuming that each country has one million weeks of labor per year. Note: cloth is represented in millions of yards, while wine is in millions of barrels. d. Portugal has an absolute advantage in the production of both goods, because it can produce more cloth and wine than Britain using the same amount of labor. Portugal has a comparative advantage in wine, because it is 3 times more productive in wine, but only 1.5 times as productive in cloth. England has a comparative advantage in cloth --the good that it is the least inefficient in producing. Notice that the slope of the PPF reflects the opportunity cost (or price) of wine in terms of cloth. The slope indicates how much cloth must be given up to produce one more wine. As stated above, a barrel of wine is cheaper in Portugal --2 yards of cloth versus 4 in England. e. When trade opens, each country will specialize in and export the good in which it has a comparative advantage. f. The traded price of wine (in terms of cloth) must lie somewhere between the pre-trade prices in the two countries. If the traded price is 5, then England will refuse to trade. It can exchange 4 yards of cloth for one barrel of wine at home, so it would not agree to buy one barrel of Portuguese wine for 5 yards of cloth. Let's assume the traded price is 3 --that is, one barrel of wine costs 3 yards of cloth. Then the gains from trade are shown in the diagram below. The dotted line represents the CPF (with trade) while the solid line is the PPF = CPF (before trade). Notice that both countries are capable of consuming more goods with trade than they were before trade, as the CPF with trade > PPF.