CFU#2: PPC and Comparative Advantage & Trade

Of the feasible and efficient points on the production possibilities curve (𝑃𝑃𝐶) above, producing at which point will lead to the most economic growth in the future?

• Point M

• Point N

• Point R

• Point J

• Point S

Answer explanation

Of the feasible and efficient points on the production possibilities curve (𝑃𝑃𝐶) above, producing at which point will lead to the most economic growth in the future?

An economy produces two goods: X and Y. Its production possibilities curve is linear with the intercept on the Y axis at 1,000 units and the intercept on the X axis at 100 units. Which of the following statements is correct?

• There is an increasing opportunity cost of producing good X, beginning with 1 unit of X costing 0.1 unit of Y.

• There is an increasing opportunity cost of producing good Y but not of producing good X, which has a constant opportunity cost.

• There is a constant opportunity cost with each unit of good X costing 10 units of good Y.

• There is a constant opportunity cost with 10 units of good X costing 1 unit of good Y.

• With a linear production possibilities curve, total production of goods X and Y will be the same at each point on the curve.

Answer explanation

Since the production possibilities curve is linear, the opportunity cost of each good, in terms of the other good, is constant. With the frontier going from an intercept of 1000 on the Y axis to 100 on the X axis, each unit of X costs 10 units of good Y and each unit of good Y cost .1 units of good X.

Assume an economy uses one input, labor, to produce two goods, X and Y, with constant opportunity cost. Which of the following would cause a parallel shift to the right of the production possibilities curve (PPC) ?

• An increase in the productivity of labor with respect to producing good X

• An increase in the amount of labor available for production

• A reduction in the unemployment of labor

• An increase in the demand for good X and good Y

• A change in consumer tastes from good Y to good X

Answer explanation

A shift in consumer preferences from good Y to good X would not increase production possibilities. Production possibilities depends on the amount of resources available and the productivity of those resources.

Cindy and Martin both sew t-shirts in a small factory. Using the same resources, Martin can sew twelve t-shirts and Cindy can sew nine t-shirts in one day. Which of the following can be concluded from the given information?

• Martin has a higher opportunity cost of sewing t-shirts than Cindy does.

• Cindy has a comparative advantage in sewing t-shirts.

• Martin has a comparative advantage in sewing t-shirts.

• Martin has an absolute advantage in sewing t-shirts.

• Cindy has an absolute advantage in sewing t-shirts.

Answer explanation

Martin has an absolute advantage in sewing t-shirts because he can sew more t-shirts than Cindy (12>9) using the same resources.

Which of the following statements regarding specialization and trade is true?

• With specialization and trade, a country’s production possibilities curve shifts out, showing an increase in productive capacity.

• With specialization and trade, a country will produce a combination of goods beyond its production possibilities curve.

• To gain from trade, countries specialize in producing goods and services in which they have an absolute advantage.

• With specialization and trade, a country can consume beyond its production possibilities curve.

• A country must have both the comparative and the absolute advantage in a product to specialize and gain from trade.

Answer explanation

With specialization and trade a country remains on its production possibilities curve but produces more of the good for which it has comparative advantage. Trading some of that good for another good would allow a country to consume beyond its production possibilities curve.

In the country Beta it takes two hours of labor to produce a unit of tea and four hours of labor to produce a unit of bread. In the country Zeta it takes three hours of labor to produce a unit of tea and nine hours of labor to produce a unit of bread. Which of the following is true?

• Country Zeta has an absolute advantage in producing both tea and bread.

• Country Zeta has an absolute advantage and a comparative advantage in producing tea.

• Country Beta has an absolute advantage and a comparative advantage in producing tea.

• Country Beta has the lower opportunity cost in producing bread and therefore a comparative advantage in producing bread.

• Country Beta, with trade, will export both tea and bread to country Zeta.

Answer explanation

A country has a comparative advantage in producing a good if it has the lowest opportunity cost of producing the good. In Beta it takes 2 hours to produce a unit of tea and 4 hours to produce a unit of bread; the opportunity cost of a unit of bread is two units of tea. In Zeta it takes 3 hours to produce a unit of tea and 9 hours to produce a unit of bread; the opportunity cost of a unit of bread is 3 units of tea. Since two teas (Beta) is less than three teas (Zeta) for a unit of bread, Beta has the comparative advantage in producing bread.