Question

A. Consider Australia and Japan which can both produce Liquified Natural Gas (LNG) or passenger vehicles. In a year, Australia can produce 80 billion tonnes of LNG or it can produce 2.0 million passenger vehicles. In a year, Japan can produce 120 billion tonnes of LNG or it can produce 6.0 million passenger vehicles.

i.        Explain which country has the comparative advantage in passenger vehicles.

ii.       If Australia were to trade its 40 billion tonnes of LNG for passenger cars from Japan, what is the minimum number of cars Australia would accept and what is the maximum number of passenger vehicles Japan would pay? Why?

B. Suppose that in Tasmania the price elasticity of demand for café meals is -0.60 and the income elasticity of demand for café meals is +1.50.

i.        Is the demand for café meals in Tasmania price elastic or price inelastic? What does this mean?

ii.       Explain using the income elasticity of demand whether café meals in Tasmania are an inferior good, necessity good or luxury good.

iii.      If the income of Tasmanians were to decrease by 20%, by how much would the demand for café meals change?

iv.      If café owners were only concerned with maximising revenue, explain why they should raise or lower the price of café meals?

Answer 1

Question A) Opportunity cost of producing passenger vehicles in Australia =

80 billion / 2 million

= 40000 tonnes of LNG.

Opportunity cost of producing passenger vehicles in Japan = 120 billion / 6 million

= 20000 tonnes of LNG.

So, we can see that the opportunity cost of producing passenger vehicles is less for Japan when compared to the opportunity cost of producing passenger vehicles in Australia.

So, Japan has a comparative advantage in the production of passenger vehicles.

ii) If Australia were to trade its 40 billion tommes of LNG for passenger cars from Japan, the minimum number of passenger vehicles Australia would accept is 1 million passenger cars. This is because if Australia would have chosen to passenger cars, it would have been able to produce 1 million passenger vehicles in place of 40 billion tonnes of LNG. So, Australia would like to accept a minimum of 1 million passenger vehicles from Japan in exchange of 40 billion tonnes of LNG.

The maximum number of passenger vehicles that Japan would pay in exchange for 40 billion tonnes of LNG is 2 million passenger vehicles. This is because if Japan would have chosen to produce LNG, it could have produced 2 million passenger vehicles in place of 40 billion tonnes of LNG. So, Japan would like to pay a maximum of 2 million passenger vehicles to Australia in exchange of 40 billion tonnes of LNG.

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