Principles of Microeconomics ECON 1101 Fall 2010 Department of Economics University of Minnesota Practice Problem on the Benefits of Trade Lectures Website Office Hours Email Tel Fax Problem 1 Consider an economy with two locations Minnesota and Illinois The locations can make two goods Sugar Beets and Soybeans Minnesota and Illinois can produce the goods as follows Minnesota Illinois Soybeans Sugar Beets 8 hours unit 5 hours unit 2 hours units 4 hours unit a Fill in the following table computing the opportunity cost of production for each good at each location Note the opportunity cost of one more soybean is in terms foregone sugar beets The opportunity cost of one more sugar beet is in terms of foregone soybeans Soybeans Sugar Beets Minnesota Illinois b Who has the absolute advantage in the production of soybeans Why c Who has the comparative advantage in the production of soybeans Why 2 Practice Problem on the Benefits of Trade d Consider the price of soybeans in terms of sugar beets What is the highest price at which soybeans can be traded that would make both states better off What is the lowest price Explain e Graph the production possibilities frontier for Illinois assuming it has 40 hours Put soybeans on the y axis f Suppose Illinois uses 20 hours to produce soybeans and 20 hours to produce sugar beets Clearly label the resulting bundle call it Bundle A produced on your PPF in part e Specifically how many soybeans and how many sugar beets are in Bundle A Department of Economics University of Minnesota Minneapolis MN 55454 3 Principles of Microeconomics ECON1101 As you answer the next few parts think about the following definitions Attainable Any combination of goods which is inside or on the Production Possiblities Frontier PPF Unattainable Any combination of goods which is outside the Production Possiblities Frontier PPF So with the resources that are give it is a combination of goods which cannot be produced Efficient Any combination of goods which is ON the Production Possiblities Frontier PPF Inefficient Any combination of goods which is not ON the Production Possiblities Frontier PPF g On the diagram in part e label a bundle that has the same amount of sugar beets as Bundle A that is attainable AND inefficient Call this Bundle B h On the diagram in part e label a bundle that has the same amount of sugar beets as Bundle A but is unattainable Call this Bundle C i If Illinois and Minnesota were to specialize in production and then trade what good should Illinois specialize in and why j Suppose the price of one soybean is 1 sugar beet Starting at Bundle A Illinois specializes in the good you chose in part i It produces one more unit of this specialized good and trades with Minnesota The new bundle consumed is Bundle D How many sugar beets and how many soybeans are in Bundle D Plot Bundle D on diagram in part e Department of Economics University of Minnesota Minneapolis MN 55454 4 Practice Problem on the Benefits of Trade Solution Part a Soybeans Minnesota Illinois Sugar Beets 8 sugar beets 5 8 soybeans 5 1 sugar beets 2 2 soybeans Part b Illinois has the absolute advantage in production of soybeans since they requires fewer resources time to produce soybeans than Minnesota Part c Illinois has the comparative advantage in the production of soybeans since they have a lower opportunity cost of production than Minnesota Part d 8 High price sugar beets If the price were any higher Minnesota would produce soybeans 5 itself Minnesota would not trade 1 Low price sugar beets If the price were lower Illinois would not cover its opportunity 2 cost Illinois would not trade Department of Economics University of Minnesota Minneapolis MN 55454 5 Principles of Microeconomics ECON1101 Part e Part f Bundle A consist of 5 sugar beats 20 20 5 and 10 soybeans 10 4 2 Part g f See the diagram in part e Part i Illinois should specialize in the production of soybeans since it has the comparative advantage Part j Bundle D consist of 5 5 sugar beats and 10 soybeans In order of Illinois to produce on more soybean they need to take 2 hours away from the production of sugar beets which would decrease the production of sugar beets by 5 units Thus the after trade production would for Illinois would be a movement along the their PPF to 4 5 sugar beets and 11 soybeans Now Illinois will trade the extra soybean they just produced to Minnesota in exchange for a sugar beet Thus Illinois will consume 5 5 sugar beets and 10 soybeans Department of Economics University of Minnesota Minneapolis MN 55454
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