ec1ps5an - Department of Economics University of California...

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1 Department of Economics Prof. Kenneth Train University of California, Berkeley Fall Semester 2009 Economics 1 Problem Set 5 – Suggested Answers 1. Let's examine a trade agreement between U.S and Mexico. We will examine a simple two good case, brooms and microchips. Each country has 10 workers who can produce either microchips or brooms. A worker in U.S can produce 9 microchips a day or 1 broom a day. A worker in Mexico can produce 1 microchip or 9 brooms a day. This can be summarize in the following table: Output per worker U.S. Mexico Microchips 9 1 Brooms 1 9 a) Draw the production possibilities frontier (PPF) of microchips and brooms for U.S. b) Draw the production possibilities frontier (PPF) of microchips and brooms for Mexico. c) Explain how trade can benefit both the U.S and Mexico. Which country will import brooms and which country microchips? The U.S. and Mexico can gain from trade with one another by taking advantage of the low cost of producing microchips in the U.S and the low cost of producing brooms in Mexico. The cost of producing one broom in U.S is 9 microchips. In Mexico the cost of producing a broom is only 1/9 microchips. If the U.S. produces microchips and imports brooms, and if Mexico produces brooms and imports microchips, both countries will gain from trade because they’ll each produce the good they can produce more cheaply and import the good that the other country produces more cheaply. Note that the U.S. has an absolute advantage in the production of microchips while Mexico has an absolute advantage in the production of brooms. U.S. PPF MEXICO PPF Microchips Microchips 90 1 0 Brooms Brooms 10 90
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2 d) Suppose the terms of trade (i.e., prices) are such that one microchip is traded for one broom. Furthermore, suppose each country wants to consume the same amount of brooms and microchips. Find (i) how many microchips and brooms are produced in each country, (ii) the consumption of brooms and microchips in each country, and (iii) the trade between U.S and Mexico. If one microchip is traded for one broom then U.S produces only
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This note was uploaded on 12/27/2009 for the course ECONOMICS intro econ taught by Professor Glennworoch during the Spring '07 term at Berkeley College.

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ec1ps5an - Department of Economics University of California...

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