Question

Use the following information to work Problems 7 and 8. Figure 3.3 on the next page) shows Tom's production possibilities and Figure 3.4 (on the next page) shows Abby's production possibilities. Tom uses all his resources and produces 2 rackets and 20 balls an hour. Abby uses all her resources and produces 2 rackets and 40 balls an hour. 7. What is Tom's opportunity cost of producing a racket? What is Abby's opportunity cost of a racket? Who has a comparative advantage in producing rackets? Who has a comparative advantage in producing balls? FIGURE 3.3 Chapter Checkpoint Study Plan Problem 7 FIGURE 3.4 Chapter Checkpoint Study Plan Problem 7 Balls per hour) Balls per hour Rackets per hour) Rackets (per hour) 8. If Tom and Abby specialize and trade 15 balls for 1 racket, what are the gains from trade?

Answer 1

(7) Tom currently producing and consuming 2 rackets and 20 balls an hour. If all resources are used to produce only one of the goods, Tom can produce 4 rackets or 40 balls. Hence the opportunity cost of producing 1 racket = 40/4 = 10 balls and opportunity cost of 1 ball = 4/40 = 0.1

Similarly, Abby currently producing and consuming 2 rackets and 40 balls an hour. If all resources are used to produce only one of the goods, Abby can produce 4 rackets or 80 balls. Hence the opportunity cost of producing 1 racket = 80/4 = 20 balls and opportunity cost of 1 ball = 4/80 = 0.05

The opportunity costs for racket and balls are mentioned below for both Tom and Abby.

Tom Abby Rackets Balls 10 0.1 200.05

Hence, Tom has comparative advantage in production of racket and Abby has comparative advantage in production of balls.

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(8) Based on the above data, Tom will specialize in racket production since the opportunity cost of producing rackets is smaller as compared to Abby. Similarly, based on the lower opportunity cost, Abby will specialize in production of balls. The lower opportunity costs are highlighted in grey in above table.

Due to specialization, Tom will produce 4 rackets and Abby will produce 80 balls. Out of 4 rackets, Tom will give 2 rackets to Abby. In return, Abby will give 30 balls out of its 80 balls. Hence, after such trade, Tom will have 2 rackets and 30 balls for consumption, while the consumption level was 2 and 20 respectively for racket and balls before trade. Hence, net benefit from trade = 30-20 = 10 balls.

On the other hand, Abby will be consuming 2 rackets before as well as after trade. However, it will be left with 50 balls after giving 30 to Tom. Hence, net gain from trade for Abby = 50-40 = 10 balls.

The pre-trade consumption, post-trade consumption and gains from trade have been summarized below.

Rackets Balls Tom Before Trade 220 After Trade 230 Gains from Trade 010 Abby Before Trade After Trade 50 Gains from Trade o 10