Eco 201 Name_______________________________ Problem Set 10 3 November 2011 Comparative Advantage 1. For each of the following, determine which country has the comparative advantage in each good, and indicate the range of possible relative prices consistent with mutually beneficial trade. Country Pounds of Fish Bushels of Wheat Opp. Cost of Fish Opp. Cost of Wheat Greece 60 80 Poland 35 70 Which country has the absolute advantage in the production of each good? ______________________ has an absolute advantage in the production of fish. ______________________ has an absolute advantage in the production of wheat. Greece has a comparative advantage in producing ________________. Poland has a comparative advantage in producing ________________. The terms of trade between Greece and Poland: The limits of the terms of trade are determined by the opportunity costs in each country. 1 pound of fish will exchange for more than 4/3 bushels of wheat but less than ____ bushels of wheat. 1 bushel of wheat will exchange for more than ____ pounds of fish but less than 3/4 pounds of fish. Country Barrels of Wine Bales of Wool Opp. Cost of Wine Opp.Cost of Wool Portugal 20 20 Great Britain 40 80 Portugal has a comparative advantage in producing ______________. The U.K. has a comparative advantage in producing ______________. The terms of trade between Portugal and Great Britain: The limits of the terms of trade are determined by the opportunity costs in each country. 1 bale of wool will exchange for more than 1/2 barrel of wine but less than ____ barrel of wine.1 barrel of wine will exchange for more than ____ bale of wool but less than 2 bales of wool. 2. Consider the information in the table below. Assume that Tennessee can produce either 20 songs or 40 cases of whisky (or a linear combination of the two) in one week. Assume that Kentucky can produce 10 songs or 50 cases of whisky (or a linear combination of the two) in one week. State Songs Whisky Opp. Cost of Songs Opp.Cost of Whisky Tennessee 20 40 Kentucky 10 50 a. Which state has a comparative advantage in the production of songs? ___________________ b. Which state has a comparative advantage in the production of whisky? _________________ c. If each state produces songs for one week and then whisky for one week, show the total production of both goods. State Songs Whisky Tennessee Kentucky Total d. Now, assume each state specializes for two weeks. Indicate the total production of both goods. Show that trade between the two states after this two week period can allow both states to consume both more whisky and songs State Songs Whisky Tennessee Kentucky Total e. After trade: State Songs Whisky Tennessee Kentucky Total3. The accompanying diagram shows the effects of a tariff. Initially, the price is P0, domestic firms produce Q0 units, and Q1 - Q0 units are imported from foreign firms. When the tariff is imposed, the price increases to P0 + t. Complete the table below, by indicating the areas that represent consumer surplus, producer surplus, government revenue, social gains, and deadweight losses. Explain why deadweight losses result from a tariff. Before Tariff After Tariff Consumer Surplus Producer Surplus Tax Revenue Social Gain Deadweight