## Thursday, November 3, 2016

### 2008 Macro FRQ #3

2008 Macro FRQ #3

(A) Calculate the opportunity cost of a bicycle in Artland.

Artland can produce 600 Hats or 300 Bikes.

The opportunity cost is what is given up, foregone, or sacrificed. Art land only makes two things so to produce more of one thing (hats) he must give up another thing (bikes).

600/300 = 2
2 / 1
Hats/bikes = 2 hats to 1 bike

If Artland produces 1 bike he gives up 2 hats

If they had asked for the opportunity cost of a hat. Reverse it.
300/600 = .5
Bikes/Hats = .5 bike to 1 hat

If Artland produces 1 hat it gives up .5 bikes

(B) If the two countries specialise and trade, which country will import bicycles? Explain.

We have to compare both sides in the making of hats and bikes.

Ray only gives up .25 of a bike to make 1 hat - most efficient - comparative advantage in hat making.
So Ray will make hats and import bikes.

Art only gives up 2 hats to make 1 bike - most efficient - comparative advantage in bikes.
Art will make bikes and import hats.

(C) If the term of trade are 5 hats for 1 bike, would trade be advantageous for each of the following?

(i) Artland
(ii) Rayland

Look at the chart again,

Ray can trade 4 hats for 1 bike - 5 hats for 1 bike is a worse deal - Not Good

Art can trade 2 hats for 1 bike - 5 hats for 1 bike is a better deal - Good

(D) If production in Artland triples, which country has the comparative advantage in hats?

So production triples, not just in hats but in bicycles also. Art land would now have the absolute advantage but the comparative advantage wouldn't have changed.

Art = 600/300 equalised = 1 to .5
Art = 1800/900 equalised = 1 to .5