Question

1. Suppose there are two countries, Wigan and Bolton. Also, suppose there are two products, lumber and sugar. For 1000 labor hours, the production capabilities are given in the table below.

	Lumber Production	Sugar Production
Wigan	8 (units)	6 (units)
Bolton	5 (units)	3 (units)

(a) Which country has the absolute advantage in producing Lumber?

(b) What is the opportunity cost (in units of Sugar) for Wigan to produce 1 Lumber?

(c) What is the opportunity cost (in units of Sugar) for Bolton to produce 1 Lumber?

(d) If there is trade between (just) Wigan and Bolton in Lumber and Sugar, which country specializes in producing Lumber? Why?

(e) Suppose Wigan and Bolton transition from no trade to trade in the two products and both countries want some of both products. What happens to the overall standard of living for Wigan? For Bolton?

The countries of Swansea and Bristol have domestic supply and demand curves for wheat as shown in the graphs below (where both price axes are in the same units). Suppose the world price is between the domestic no trade prices of the two countries.

Bristol

Swansea

P

SDom

P

SDom

DDom

DDom

Q

Q

2. Consider what happens in Swansea as it transitions from no trade in wheat to trade in wheat.

(a) What happens to the price of wheat in Swansea?

(b) What happens to the domestic quantity of wheat purchased?

(c) What happens to the domestic quantity of wheat produced?

(d) Does Swansea export or import wheat?

(e) What group (producers or consumers) gains from the transition?

(f) What group (producers or consumers) loses from the transition?

(g) What group (producers or consumers) has the bigger change of surplus because of the transition?

(h) Does Swansea as a whole gain or lose from the transition?

3. Consider what happens in Bristol as it transitions from no trade in wheat to trade in wheat.

(a) What happens to the price of wheat in Bristol?

(b) What happens to the domestic quantity of wheat purchased?

(c) What happens to the domestic quantity of wheat produced?

(d) Does Bristol export or import wheat?

(e) What group (producers or consumers) gains from the transition?

(f) What group (producers or consumers) loses from the transition?

(g) What group (producers or consumers) has the bigger change of surplus because of the transition?

(h) Does Bristol as a whole gain or lose from the transition?

Answer 1

1.

a) Wigan clearly has an absolute advantage in the production of lumber than Bolton as it produces more units of Lumber per thousand labour hours than Bolton does in the same labour hours.

b) The opportunity cost (in units of Sugar) for Wigan to produce 1 Lumber is 6/8 = 0.75

c) The opportunity cost (in units of Sugar) for Bolton to produce 1 Lumber is 3/5 = 0.6

d) Country with lower opportunity cost will have comparative advantage in the production of Lumber. Here, Bolton has a lower opportunity cost and thus, it has a comparative advantage in the production of Lumber. This being the case, Bolton specializes in producing Lumber if there is trade between the two countries in Lumber and Sugar.