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Unformatted text preview: Intermediate Microeconomics, Winter 2008 Problem Set No 14 - Solutions This problem set will not be collected. Please, answer the following questions from the book: 10.14, 10.15, 10.14) If Jane and Denise have identical, linear production possibility fron- tiers, are there gains to trade? Explain. Answer: No, both Jane and Denise have the same opportunity cost of pro- duction so specialization would not create any value. 10.15) Suppose Britain can produce 10 units of cloth or 5 units of food per day (or any linear combination) with available resources and that Greece can produce 2 units of food per day or 1 unit of cloth (or any combination). Britain has an absolute advantage in producing both goods. Does it still make sense for these countries to trade? Explain. Answer: Yes, they could still trade. The opportunity cost of cloth is 1 2 unit of food in Britain and is 2 units of food in Greece. Britain has a comparative advantage in cloth and Greece in food, thus gains from trade are possible. Q1) The above figure depicts the Edgeworth box for two consumers, Al and Bruce. Explain why point a cannot be a competitive equilibrium. 1 Answer: Point a is not efficient. To see this, compare to either point c or d. The First Welfare Theorem states that every competitive equilibrium is efficient, therefore point a could not be a competitive equilibrium. Q2) Explain how it is possible for one of two people in a two-good economy to have an absolute advantage in producing both goods, but trade can still ben- efit both people. Answer: Trade can always help both parties when there is comparative ad- vantage. The relevant question is not what is the total amount of goods 1 and 2 that I can produce but rather how many units of good 2 did I have to give up to make the last unit of good 1? If the latter amount differs between the two parties in the economy, there will be gains from trade....
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- Winter '08