PS 1 solutions

PS 1 solutions - Problem Set #1: Solutions Due July 1st,...

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Problem Set #1: Solutions *Econ S-1530 Due July 1st, 2010 Comparative Advantage and Money Stock 1. (40 points) The output of labor (assumed to be the only input involved) in production of wine and of cloth in two countries, Upper Utopia and Lower Utopia, is as follows: Table 1: Production Per Hour Upper Utopia Lower Utopia Yard of cloth 5 15 Quarts of wine 10 20 Please show all work and/or provide an explanation of your answer. a) Comparing the two countries as to possible trade between them and as to production advantages, it would be correct to say that Upper Utopia has (1) an absolute advantage in cloth production (2) an absolute advantage in wine production (3) a comparative advantage in cloth production (4) a comparative advantage in wine production (5) a comparative advantage in neither commodity Answer: The rate at which Upper Utopia can transform wine production into cloth production is given by the ratio of the amount of wine that labor can produce to the amount of cloth that labor can produce: Upper Utopia must give up 0.5 yards of cloth to get a quart of wine. Similarly, the rate at which Lower Utopia can make this transformation is 5 y. cloth/hour = 1 y. cloth 10 q. wine 2 q. wine 15 y. cloth/hour = 1 y. cloth/hour 20 q. wine/hour 1.33 q. wine 1
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Wine is relatively more expensive to produce in Lower Utopia than Upper Utopia. Lower Utopia must give up 0.75 yards of cloth to get a quart of wine, while Upper Utopia must give up only 0.5 yards of cloth. Hence, Upper Utopia has a comparative advantage in wine and the answer is (4). b) If trade is opened, what will be the direction of trade? i.e. who exports/imports what? Answer: Remember, we use comparative advantage. Therefore, although Lower Utopia is a more efficient producer of both cloth and wine, Upper Utopia is still relatively better at producing wine compared to Lower Utopia. This means that Upper Utopia will export wine, and import cloth.
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This note was uploaded on 10/21/2010 for the course ECON 1530 taught by Professor Ohly during the Spring '10 term at Dartmouth.

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PS 1 solutions - Problem Set #1: Solutions Due July 1st,...

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