ECON 162-A1, A2 Kenny Christianson
Fall 2018 due: September 14
ANSWER KEY – PROBLEM SET NUMBER TWO
1. a. If there is an increase in the labor force, then the economy can produce more of both
goods:
M
let M = manufactured goods
A = agricultural goods
PPC PPC’
b. If a new tractor is introduced, Boringtown can produce more agricultural goods if all
resources are devoted to agricultural goods:
PPC PPC’
c. If the largest factory burns down, there will be a decrease in the manufactured goods
intercept:
PPC’ PPC
The PPC for Boringtown is concave due to the Law of Increasing Cost, which arises due
to the specialization of resources.
Econ 162-A1, A2 Fall 2018 Answer Key Two 2
2. a. Chris has a lower opportunity cost in cleaning the apartment, since he would be
giving up less income to stay home for the day. Since it takes each of you two days to
clean the apartment, your opportunity cost to clean the apartment would be $200, while
Chris would only have to give up $100.
b. Chris should clean the apartment since he (or she) has a lower opportunity cost.
Without specialization, you would each spend one day working and one day cleaning. In
two days, you would both have a clean apartment, you would earn $100 for working one
day, and Chris would earn $50.
With specialization, Chris would clean the apartment in two days and you would
work for two days. You would earn $200 by working for two days. You would be both
willing to have Chris clean the apartment for anything between $50 and $100 dollars. If
you paid Chris $75, for example, to clean the apartment, you would both be better off.
You would have a clean apartment and $125, rather than the $100 you could earn in one
day without specialization. Chris would have a clean apartment and $75, rather than the
$50 that he could earn in one day.
3. . a. The authors conducted surveys of large, diverse samples from four countries, the
United States, Canada, Denmark and the Netherlands. They asked working adults to
spend money on a material purchase and a time-saving purchase, and then recorded
reported changes in happiness.
b. The authors found that
individuals who spend money on time-saving services report greater life satisfaction. A field
experiment provides causal evidence that working adults report greater happiness after
spending money on a time-saving purchase than on a material purchase.
Simply, spending money to free up time increases happiness and reported life
satisfaction. While the purchases had no discernable effect on time stress, those who
were able to make time-saving purchases were better able to deal with the time stress and
the time stress had less effect on personal happiness.
c. The implications for comparative advantage are that specialization increases
happiness. Those who are able to free up some time for more enjoyable activities report
greater life satisfaction.
4. a. Britain is more efficient at producing both champagne and muffins, since it can
produce more of both goods with the same quantity of resources. Britain has an absolute
advantage in the production of both goods.
Next, find the opportunity costs:
b. For France, c. For Britain,
4000C = 1000M 8000C = 4000M
1C = (1/4)M 1C = (1/2)M
1M = 4C 1M = 2C
Econ 162-A1, A2 Fall 2018 Answer Key Two 3
b. For France, the opportunity cost of a bottle of champagne is ¼ of a muffin, and the
opportunity cost of a muffin is 4 bottles of champagne.
c. For Britain, the opportunity cost of a bottle of champagne is ½ of a muffin, and the
opportunity cost of a muffin is 2 bottles of champagne.
d. Yes, France and Britain should specialize and trade. France has a comparative
advantage in champagne since it has a lower opportunity cost in producing
champagne ((1/4)M vs. (1/2)M). So France should specialize in champagne
production.
Britain has a comparative advantage in muffins since it has a lower opportunity
cost in producing muffins (2C vs. 4C). So Britain should specialize in muffin
production.
e. The terms of trade depend on the opportunity costs of production.
First, France is specializing in champagne production. On its own, France would
have to give up 4 bottles of champagne for a muffin. As long as France is able to
give up less than 4 bottles of champagne through trade for a muffin, it will be
better off. It will be giving up less champagne through trade than it would have to
give up on its own to get a muffin.
Second, Britain is specializing in muffins. On its own, it could give up a muffin
and get two bottles of champagne. As long as Britain is able to get more than two
bottles of champagne through trade for a muffin, it will be better off. Britain
would be receiving more champagne through trade than it could produce on its
own by giving up a muffin.
So both would be willing to trade 1 muffin for 3 champagne, or 1000 muffins for
3000 bottles of champagne. You can show that both countries would be better off:
C C
4000 8000
3000C
3000 CPC
CPC 2000
1000
PPC 3000C PPC
1000 M 3000 4000 M
1000M 1000M
FRANCE BRITAIN
Econ 162-A1, A2 Fall 2018 Answer Key Two 4
France is better off through trade. On its own, it could produce 1000 muffins and 0
bottles of champagne. With trade, France can consume 1000 muffins and 1000 bottles of
champagne, so it is better off.
Similarly, Britain is better off through trade. On its own, Britain could produce
3000 muffins and 2000 bottles of champagne. With trade, Britain can consume 3000
muffins and 3000 bottles of champagne, so Britain is better off.
So – both countries are made better off through specialization and trade.
5 a. Three of the websites support free trade – Alan Blinder’s entry, the Heritage
Foundation, and the WTO. The other three websites, Global Exchange, Fairtrade
America, and the Fair Trade Federation, are critical of free trade.
Alan Blinder states the basic economic argument in favor of free trade. Adam
Smith argued that we should buy from other countries if they can produce more cheaply.
This is the idea of absolute advantage, which states that tasks should be assigned to those
with the lowest resource costs.
In the early 1800s David Ricardo developed the idea of comparative advantage.
Even if a country can produce more of both goods, there is still a benefit through
specialization and trade. Each country frees up resources to produce where it is more
efficient. Specialization and productivity enable countries to pay different wages.
Blinder points out that the free trade between the American states leads to the largest free
trade zone in the world, and the American economy as a whole is stronger because states
are able to freely trade with each other.
The Heritage Foundation points out the benefits of free trade in promoting
prosperity and in reducing poverty around the world. It has the potential to promote
innovation and reduce corruption.
The WTO website also supports free trade, “it’s an organization for liberalizing
trade.” The primary function of the WTO is “dealing with rules of trade between nations.
At its heart are the WTO agreements, negotiated and signed by the bulk of the world’s
trading nations and ratified in their parliaments. The goal is to help producers of goods
and services, exporters, and importers conduct their business.”
The advantages of specialization and free trade include increased production of
goods and services, a higher standard of living through the creation of wealth, lower
consumer prices, and a greater variety of goods and services. Trade also enables us to
have more influence around the world. The beneficiaries of free trade include
consumers, importers, and those who are provided jobs which increase their standard of
living. The losers include domestic workers who lose their jobs and those who have to
live with declining workplace and environmental conditions.
b. The other three websites, Global Exchange, Fairtrade America and the Fair Trade
Federation, are opposed to free trade. The disadvantages of specialization and free trade
include a possible loss of national security, transactions and information costs, and a lack
of diversity if an economy specializes in producing only one good. Many opponents of
the WTO, such as Global Exchange, point to the issues of the loss of domestic jobs,
exploitation of labor, child labor, workplace health and safety issues (sweatshops),
environmental concerns, and the undemocratic nature of WTO decisions. If countries are
forced to compete with each other, there may be a “race to the bottom.” “The Fairtrade
system works to empower small-scale farmers and workers marginalized by trade.”
Econ 162-A1, A2 Fall 2018 Answer Key Two 5
Finally, the Fair Trade Federation supports the concept of fair trade. It recognizes
that economic partnerships between countries are necessary to alleviate poverty. It seeks
to “create opportunities for economically and socially marginalized producers around the
world” through the promotion of fair trade. Basically, fair trade consists of trade between
countries with a goal of social and economic justice.
Overall, we cannot hope to have much influence over environmental and working
conditions in other countries if we refuse to trade with them.
c. The WTO is the World Trade Organization. It is an international organization of
164 countries founded in 1995 to reduce trade barriers around the world.
d. Free trade is an absence of trade barriers such as tariffs or quotas. Fair trade is
trade with a goal of social and economic justice. It recognizes the benefits of trade, but it
tries to use trade to benefit disadvantaged peoples rather than harm them.
