Question

2. There is an economy consisting of only two people, Fred and Robin, who produce and consume two goods: gallons of juice and gallons of beer. In 1 week, Robin can produce 25 gallons of juice or 5 gallons of beer. Fred can produce 12 gallons of juice or 4 gallons of beer. Assume both goods can be produced in continuous quantities. a) Determine who has the comparative advantage in each good. Show the numbers that led to this conclusion. Use this information to help draw the PPF for the economy with gallons of juice on the vertical axis. Be sure to specifically label both intercepts, give the MRT at every point and give the specific coordinates of any point where the MRT changes. (1 point) b) Explain why Robin having 9 gallons of juice and 4 gallons of beer and Fred having 11 gallons of juice and 1 gallons of beer is not possible without trade. Give the production of each person and the trade that makes this outcome possible. (2 points)

Answer 1

a)

Robin can either produce 25 gallons of juice or 5 gallons of beer in the given resources. The relative value for Robin is
5 gallons of juice = 1 gallon of beer
The opportunity cost of a gallon of juice is 0.20 gallon of beer
1 / 5 = 0.2

Juice Robin 1 2 4 5 6 7 8 Beer 3 Fred

Fred can produce 12 gallons of juice or 4 gallons of beer and so that his relative value is
3 gallons of juice = 1 gallon of beer.
The opportunity cost for Fred is 0.33 gallons of beer for a gallon of juice.

Since Robin has a lower opportunity cost for producing juice then it means he has a comparative advantage in producing juice while Fred has a comparative advantage in producing beer.

b) Robin himself can not produce 9 gallons of juice and 4 gallons of beer simultaneously. He will have to forfeit 5 gallons of beer for every gallon of beer. So having 4 gallons of beer means he will have only 5 gallons of juice.
Similarly, Fred will have to forfeit 3 gallons of juice for every gallon of beer. Fred will have 9 gallons of juice if he chooses to have a gallon of beer also.
The mentioned combination lies outside the PPF curve and not achievable in the current scenario.

Fred and Robin will specialize in beer and juice respectively. In that case, the total production will be 25 gallons of juice and 4 gallons of beer. Then they can trade with each other with excess quantities.
Robin will trade 14 gallons of juice and Fred will be ready to trade 4 gallons of beer.