Principles of Microeconomics Semester A 2020-2021

Problem Set #2 – The Gains from Trade

This document contains 7 pages

Lecturer: Dr. Yael Hadass

Teaching Assistant: Avigayil Rabhan

Grader: Ira Friedman.

PartA: Open questions that require calculations

1. In the world there are two economies: A and B. Each economy produces wheat and
guns with one factor of production: Labor.

In economy A there are 100 workers, each can produce 1 unit of wheat or 2 units of
guns.
In economy B there are 100 workers, each can produce 2 units of wheat or 1 unit of
guns.
Assume that initially there is no trade between the economies.

Wheat Guns
The Workers in economy A 100 200
The Workers in economy B 200 100

a. What is the opportunity cost for producing 1 unit of wheat in each economy?
What is the opportunity cost for producing 1 unit of a gun in each economy?

b. Which economy has a comparative advantage in producing wheat?

Which economy has a comparative advantage in producing guns?

c. Assume that each economy decides to produce and consume half of the
maximum amount of wheat that it can produce.
a. Find what is the maximum quantity of wheat that the economy can
produce? The current consumption and production point equals to half of
this quantity.
b. Show the PPF and the consumption point of each economy, assuming that
no trade occurs. Calculate the algebraic form of the PPF.

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 Building the PPF:

Country A Country B

Wheat Wheat

Guns Guns

d. Use the algebraic form of the PPF of country A to calculate, whether it is

possible to consume 75 units of wheat and 125 units of guns in economy A?
Is it possible to consume 125 units of wheat and 75 units of guns in economy B?

i. Assume now that there is a possibility for the economies to trade and the
price 1 unit of wheat equals to 1 unit of gun (in other words, one unit of
wheat can be traded for one gun). Is it beneficial for the economies to
trade?
Notice: This is a more advance question so don’t feel bad if you don’t
succeed at the first attempt. Please try to solve it and if you don’t get it
Avigayil will work with you about this in recitation.
Instructions: Calculate and draw the line that shows the consumption
possibilities of each country if they are able to trade.
Directions:
a. find what is the maximum quantity of each good that they can
consume if they trade.
b. Draw a line in the same graph of the PPF. You should get a line
that is different from the PPF. If the new line is above the PPF,
what does it means regarding the benefit of trade?
ii. If it is beneficial, assume that each economy specializes in producing the
goods that it has a comparative advantage in. How many units of each one
of the goods will each economy produce?
iii. Assume that the two economies trade. Assume that economy A wants to consume
75 units of wheat. Show on the graph – how many units of each good will

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 economy A produce? Also how many units of each good will economy A
consume?

2. In this question you are required to build a production possibility frontier, similarly to
the example that you have seen in class.

Data:
Type A can produce 1 unit of X or 1 Unit of Y
Type B can produce 2 units of X or 6 units of Y
Type C can produce 4 units of X or 2 units of Y

X Y
Workers A 1 1
Workers B 2 6
Workers C 4 2

Remember that we will allocate the workers according to their opportunity costs,
the most efficient worker first.

Part B: Multiple Choice Questions

1. Economists believe that production possibilities frontiers

a. never have a bowed shape.
b. rarely have a bowed shape.
c. often have a bowed shape.
d. always have a bowed shape.

2. A production possibilities frontier shifts outward when

a. the economy experiences economic growth (i.e it can produce more than it
could before).
b. the desires of the economy’s citizens change.
c. at least one of the basic principles of economics is violated.
d. opportunity costs are lessened.

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3. A certain production possibilities frontier shows production possibilities for two
goods, Jewelry and clothing. Which of the following concepts cannot be illustrated by
this model?
a. the flow of dollars between sellers of Jewelry and clothing and buyers of
Jewelry and clothing
b. the tradeoff between production of Jewelry and production of clothing
c. the opportunity cost of clothing in terms of Jewelry
d. the effect of economic growth on production possibilities involving Jewelry
and clothing

4. Relate to the following claims:

i. If there are two goods and two countries, each country will always have an
absolute advantage in one of the goods.
ii. If there are two goods and two countries, each country will always have a
comparative advantage in one of the goods.
iii. An economy can't have absolute advantage in producing all the goods

a. Only claim (i) is correct

b. Only claim (ii) is correct
c. Only claim (iii) is correct
d. There is more than one correct claim