Interdependence and the Gains from Trade TRUE/FALSE 1. In most countries today, many goods and services consumed are imported from abroad, and many goods and services produced are exported to foreign customers. ANS: T 2. Interdependence among individuals and interdependence among nations are both based on the gains from trade. ANS: T 3. If a person chooses self-sufficiency, then she can only consume what she produces. ANS: T 4. If Wrex can produce more math problems per hour and more book reports per hour than Maxine can, then Wrex cannot gain from trading math problems and book reports with Maxine. ANS: F 5. It is possible for the U.S. to gain from trade with Germany even if it takes U.S. workers fewer hours to produce every good than it takes German workers. ANS: T 6. A production possibilities frontier is a graph that shows the combination of outputs that an economy should produce. ANS: F 7. Production possibilities frontiers cannot be used to illustrate tradeoffs. ANS: F 8. An economy can produce at any point on or inside its production possibilities frontier, but it cannot produce at points outside its production possibilities frontier. ANS: T 9. Trade allows a country to consume outside its production possibilities frontier. ANS: T 10. Opportunity cost refers to how many inputs a producer requires to produce a good. ANS: F 11. Opportunity cost measures the trade-off between two goods that each producer faces. ANS: T 12. For a country producing two goods, the opportunity cost of one good will be the inverse of the opportunity cost of the other good. ANS: T 13. Henry can make a bird house in 3 hours and he can make a bird feeder in 1 hour. The opportunity cost to Henry of making a bird house is 1/3 bird feeder. ANS: F 14. Suppose that in one hour Dewey can produce either 10 bushels of corn or 20 yards of cloth. Then Dewey’s opportunity cost of producing one bushel of corn is 1/2 yard of cloth. ANS: F 15. Jake can complete an oil change in 45 minutes and he can write a poem in 90 minutes. Ming-la can complete an oil change in 30 minutes and she can write a poem in 90 minutes. Jake's opportunity cost of writing a poem is lower than Ming-la's opportunity cost of writing a poem. ANS: T 16. Harry is a computer company executive, earning $200 per hour managing the company and promoting its products. His daughter Quinn is a high school student, earning $6 per hour helping her grandmother on the farm. Harry's computer is broken. He can repair it himself in one hour. Quinn can repair it in 10 hours. Harry’s opportunity cost of repairing the computer is lower than Quinn’s. ANS: F 17. If one producer has the absolute advantage in the production of all goods, then that same producer will have the comparative advantage in the production of all goods as well. ANS: F 18. If a country has the comparative advantage in producing a product, then that country must also have the absolute advantage in producing that product. ANS: F 19. In an economy consisting of two people producing two goods, it is possible for one person to have the absolute advantage and the comparative advantage in both goods. ANS: F 20. If one producer is able to produce a good at a lower opportunity cost than some other producer, then the producer with the lower opportunity cost is said to have an absolute advantage in the production of that good. ANS: F 21. Unless two people who are producing two goods have exactly the same opportunity costs, then one person will have a comparative advantage in one good, and the other person will have a comparative advantage in the other good. ANS: T 22. Zora can produce 4 quilts in a week and she can produce 1 corporate website in a week. Lou can produce 9 quilts in a week and he can produce 2 corporate websites in a week. Zora has the comparative advantage in quilts and the absolute advantage in neither good, while Lou has the comparative advantage in corporate websites and the absolute advantage in both goods. ANS: F 23. Timmy can edit 2 pages in one minute and he can type 80 words in one minute. Olivia can edit 1 page in one minute and she can type 100 words in one minute. Timmy has an absolute advantage and a comparative advantage in editing, while Olivia has an absolute advantage and a comparative advantage in typing. ANS: T 24. Suppose Hank and Tony can both produce corn. If Hank’s opportunity cost of producing a bushel of corn is 2 bushels of soybeans and Tony’s opportunity cost of producing a bushel of corn is 3 bushels of soybeans, then Hank has the comparative advantage in the production of corn. ANS: T 25. It takes Anne 3 hours to make a pie and 4 hours to make a shirt. It takes Mary 2 hours to make a pie and 5 hours to make a shirt. Anne should specialize in making shirts and Mary should specialize in making pies, and they should trade. ANS: T 26. The principle of comparative advantage states that, regardless of the price at which trade takes place, everyone will benefit from trade if they specialize in the production of the good for which they have a comparative advantage. ANS: F 27. The gains from specialization and trade are based on absolute advantage. ANS: F 28. Trade can benefit everyone in society because it allows people to specialize in activities in which they have a comparative advantage. ANS: T 29. Two countries can achieve gains from trade even if one country has an absolute advantage in the production of both goods. ANS: T 30. It takes Ross 6 hours to produce a bushel of corn and 2 hours to wash and polish a car. It takes Courtney 6 hours to produce a bushel of corn and 1 hour to wash and polish a car. Courtney and Ross cannot gain from specialization and trade, since it takes each of them 6 hours to produce 1 bushel of corn. ANS: F 31. Differences in opportunity cost allow for gains from trade. ANS: T 32. As long as two people have different opportunity costs, each can gain from trade with the other, since trade allows each person to obtain a good at a price lower than his or her opportunity cost. ANS: T 33. Trade allows a person to obtain goods at prices that are less than that person's opportunity cost because each person specializes in the activity for which he or she has the lower opportunity cost. ANS: T 34. When each person specializes in producing the good in which he or she has a comparative advantage, each person can gain from trade but total production in the economy is unchanged. ANS: F 35. For both parties to gain from trade, the price at which they trade must lie exactly in the middle of the two opportunity costs. ANS: F 36. Adam Smith was the author of the 1776 book An Inquiry into the Nature and Causes of the Wealth of Nations. ANS: T 37. David Ricardo was the author of the 1817 book Principles of Political Economy and Taxation. ANS: T 38. Adam Smith wrote that a person should never attempt to make at home what it will cost him more to make than to buy. ANS: T 39. Adam Smith developed the theory of comparative advantage as we know it today. ANS: F 40. Goods produced abroad and sold domestically are called exports and goods produced domestically and sold abroad are called imports. ANS: F 41. International trade may make some individuals in a nation better off, while other individuals are made worse off. ANS: T 42. For international trade to benefit a country, it must benefit all citizens of that country. ANS: F 43. Some countries win in international trade, while other countries lose. ANS: F 44. Trade can make some individuals worse off, even as it makes the country as a whole better off. ANS: T 45. Trade allows all countries to achieve greater prosperity. ANS: T SHORT ANSWER 1. Explain the difference between absolute advantage and comparative advantage. Which is more important in determining trade patterns, absolute advantage or comparative advantage? Why? ANS: Absolute advantage refers to productivity, as in the producer who can produce a product at a lower cost in terms of the resources used in production. Comparative advantage refers to the producer who can produce a product at a lower opportunity cost. Comparative advantage is the principle upon which trade patterns are based. Comparative advantage is based on opportunity cost, and opportunity cost measures the real cost to an individual or country of producing a particular product. Opportunity cost is therefore the information necessary for an individual or nation to determine whether to produce a good or buy it from someone else. 2. The only two countries in the world, Alpha and Omega, face the following production possibilities frontiers. Alpha’s Production Possibilities Frontier Omega’s Production Possibilities Frontier popcorn popcorn 300 300 275 275 250 250 225 225 200 200 175 175 150 150 125 125 100 100 75 75 50 50 25 25 25 a. b. c. d. 50 75 100 125 150 175 200 225 250 peanuts 25 50 75 100 125 150 175 200 225 peanuts Assume that each country decides to use half of its resources in the production of each good. Show these points on the graphs for each country as point A. If these countries choose not to trade, what would be the total world production of popcorn and peanuts? Now suppose that each country decides to specialize in the good in which each has a comparative advantage. By specializing, what is the total world production of each product now? If each country decides to trade 100 units of popcorn for 100 units of peanuts, show on the graphs the gain each country would receive from trade. Label these points B. ANS: Alpha’s Production Possibilities Frontier Omega’s Production Possibilities Frontier popcorn popcorn 300 300 275 275 250 250 225 225 200 200 175 175 150 150 125 B 100 75 Consumption with trade A 50 B Consumption with trade A 125 100 75 50 25 25 25 50 75 100 125 150 175 200 225 250 peanuts 25 50 75 100 125 150 175 200 225 peanuts a. b. c. d. 3. Alpha would be producing 125 units of peanuts and 75 units of popcorn (point A on its production possibilities frontier) and Omega would be producing 50 units of peanuts and 150 units of popcorn (point A on its production possibilities frontier). The total world production of peanuts would be 175 units and the total world production of popcorn would be 225 units. The total world production of peanuts would now be 250 units and the total world production of popcorn would now be 300 units. Alpha would be producing 250 units of peanuts and would trade 100 of them to Omega, leaving Alpha with 150 units of peanuts. Alpha would then receive 100 units of popcorn from Omega. Omega would be producing 300 units of popcorn and would trade 100 of them to Alpha, leaving Omega with 200 units of popcorn. Omega would then receive 100 units of peanuts from Alpha. Julia can fix a meal in 1 hour, and her opportunity cost of one hour is $50. Jacque can fix the same kind of meal in 2 hours, and his opportunity cost of one hour is $20. Will both Julia and Jacque be better off if she pays him $45 per meal to fix her meals? Explain. ANS: Since Julia's opportunity cost of preparing a meal is $50, and Jacque's opportunity cost of preparing a meal is $40, each of them will be better off by $5 per meal if this arrangement is made. 4. Gary and Diane must prepare a presentation for their marketing class. As part of their presentation, they must do a series of calculations and prepare 50 PowerPoint slides. It would take Gary 10 hours to do the required calculation and 10 hours to prepare the slides. It would take Diane 12 hours to do the calculations and 20 hours to prepare the slides. a. b. c. How much time would it take the two to complete the project if they divide the calculations equally and the slides equally? How much time would it take the two to complete the project if they use comparative advantage and specialize in calculating or preparing slides? If Diane and Gary have the same opportunity cost of $5 per hour, is there a better solution than for each to specialize in calculating or preparing slides? ANS: a. b. c. If both tasks are divided equally, it will take 11 hours for the calculations and 15 hours for the writing, for a total of 26 hours. If Diane specializes in calculating and Gary specializes in preparing slides, it will take 22 hours to complete the project. If Diane specializes in calculating, her opportunity cost will be $60; hence, Diane would be better off if she paid Gary any amount less than $60 to do the calculating. Since Gary's opportunity cost of doing the calculations is only $50, he would be better off if Diane paid him between $50 and $60 dollars to do the calculations. In this case, the total time spent on the project would be 20 hours. Interdependence and the Gains from Trade MULTIPLE CHOICE 1. People who provide you with goods and services a. b. c. d. are acting out of generosity. do so because they get something in return. have chosen not to become interdependent. are required to do so by the government. ANS: B 2. When an economist points out that you and millions of other people are interdependent, he or she is referring to the fact that we all a. b. c. d. rely upon the government to provide us with the basic necessities of life. rely upon one another for the goods and services we consume. have similar tastes and abilities. are concerned about one another’s well-being. ANS: B Sec01 - Interdependence and the Gains from Trade - A Parable for the Modern Economy MULTIPLE CHOICE 1. Which of the following is not a reason people choose to depend on others for goods and services? a. b. c. d. to improve their lives to allow them to enjoy a greater variety of goods and services to consume more of each good without working any more hours to allow people to produce outside their production possibilities frontiers ANS: D 2. When can two countries gain from trading two goods? a. b. c. d. when the first country can only produce the first good and the second country can only produce the second good when the first country can produce both goods, but can only produce the second good at great cost, and the second country can produce both goods, but can only produce the first good at great cost when the first country is better at producing both goods and the second country is worse at producing both goods Two countries could gain from trading two goods under all of the above conditions. ANS: D 3. Regan grows flowers and makes ceramic vases. Jayson also grows flowers and makes ceramic vases, but Regan is better at producing both goods. In this case, trade could a. b. c. d. ANS: A benefit both Jayson and Regan. benefit Jayson, but not Regan. benefit Regan, but not Jayson. benefit neither Jayson nor Regan. 4. Ben bakes bread and Shawna knits sweaters. Ben and Shawna both like to eat bread and wear sweaters. In which of the following cases is it impossible for both Ben and Shawna to benefit from trade? a. b. c. d. Ben cannot knit sweaters and Shawna cannot bake bread. Ben is better than Shawna at baking bread and Shawna is better than Ben at knitting sweaters. Ben is better than Shawna at baking bread and at knitting sweaters. Both Ben and Shawna can benefit from trade in all of the above cases. ANS: D 5. Shannon bakes cookies and Justin grows vegetables. In which of the following cases is it impossible for both Shannon and Justin to benefit from trade? a. b. c. d. Shannon does not like vegetables and Justin does not like cookies. Shannon is better than Justin at baking cookies and Justin is better than Shannon at growing vegetables. Justin is better than Shannon at baking cookies and at growing vegetables. Both Shannon and Justin can benefit from trade in all of the above cases. ANS: A 6. The production possibilities frontier illustrates a. b. c. d. the combinations of output that an economy should produce. the combinations of output that an economy should consume. the combinations of output that an economy can produce. All of the above are correct. ANS: C 7. An economy’s production possibilities frontier is also its consumption possibilities frontier a. b. c. d. under all circumstances. under no circumstances. when the economy is self-sufficient. when the rate of tradeoff between the two goods being produced is constant. ANS: C 8. A production possibilities frontier is bowed outward when a. b. c. d. ANS: D the more resources the economy uses to produce one good, the fewer resources it has available to produce the other good. an economy is self-sufficient instead of interdependent and engaged in trade. the rate of tradeoff between the two goods being produced is constant. the rate of tradeoff between the two goods being produced depends on how much of each good is being produced. 9. A production possibilities frontier is a straight line when a. the more resources the economy uses to produce one good, the fewer resources it has available to produce the other good. an economy is interdependent and engaged in trade instead of self-sufficient. the rate of tradeoff between the two goods being produced is constant. the rate of tradeoff between the two goods being produced depends on how much of each good is being produced. b. c. d. ANS: C 10. The following table contains some production possibilities for an economy for a given month. Sweaters 4 6 8 Gloves 300 ? 100 If the production possibilities frontier is bowed outward, then “?” could be a. b. c. d. 100. 150. 200. 250. ANS: D 11. The following table contains some production possibilities for an economy for a given month. Sweaters 4 6 8 a. b. c. d. Gloves 300 ? 100 If the production possibilities frontier is a straight line, then “?” must be 100. 150. 200. 250. ANS: C 12. The following table contains some production possibilities for an economy for a given year. Cars 10 12 14 a. b. c. d. Newspapers 400 360 ? If the production possibilities frontier is bowed outward, then “?” could be ANS: D 340. 330. 320. 310. 13. The following table contains some production possibilities for an economy for a given year. Cars 10 12 14 a. b. c. d. Newspapers 400 360 ? If the production possibilities frontier is a straight line, then “?” must be 340. 330. 320. 310. ANS: C 14. The following table contains some production possibilities for an economy for a given month. Bagels 40 60 80 a. b. c. d. Donuts 150 ? 50 If the production possibilities frontier is bowed outward, then “?” could be 50. 75. 100. 125. ANS: D 15. The following table contains some production possibilities for an economy for a given month. Bagels 40 60 80 Donuts 150 ? 50 If the production possibilities frontier is a straight line, then “?” must be a. b. c. d. ANS: C 50. 75. 100. 125.