The Social and Detail Division of Labor: My neighbors Tom and Diane live on corn

Question

The Social and Detail Division of Labor: My neighbors Tom and Diane live on corn and pot. Each can produce both at the following rate (output per day):

Ted

Jane

Pot

4

2

Corn

16

4

a) Draw production possibility frontiers for Tom and Diane producing the two goods (pot and corn) without trade. What is the relative price of pot and corn for each?

b) If Tom and Diane can trade services, in which will each specialize? Show how trade shifts the PPFs for each.

c) Who gains from trade?

Ted

Jane

Pot

4

2

Corn

16

4

Explanation / Answer

Inthis problem, Ted and Jane are two persons. They can produce Pot and Corn. The production quantity per day of each are given below. Here they are using either full day in producing Pot or in Corn. If both are produced in a cday then different combinations are possible. Cosider all such combiations to draw a line. It is known as production possibility frontier. Curves are shown below:

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Relative price to Ted is 4:16=1:4. So one unit of Pot will be exchanged for 4 units of corn.

Relative price to Jane is 2:4=1:2. So one unit of pot can be exchaged for 2 units of corn.

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Answer (b) If Ted and Jane trade, then each will specialize in the product in which it has comparative advatage. First consider production of Pot.,

Ted can manufacture 4 pot or 16 corn per day. So for producing one pot he has to sacrifice 4 units of corn. Thus opportunity cost of of one unit pot to Ted is 4 units of corn.

For Jane, 2 units of Pot is equivalent to 4 units of corn. Thus for producing one pot he will sacrifice only 2 units of corn. Thus opportunity cost of pot is low to Jane. So he has comparative advantage in the maufacture of Pot. So Jane will specialize in Pot and will produce 2 pot in a day.

Next consider Corn. Ted is sacrificing 4/16=0.25 pot per day to manufacture one unit of corn. thus his opportunity cost of corn is 0.25 pot. For Jane it is 2/4=0.5. Thus Ted has comparative advantage in the production of Corn. He will only produce corn. In diagram below green PPP line will be observed for the two. Jane will concentrate at intersection point of horizontal axis. Ted will specialize at the intersection point of vertical axis.

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Answer c:

So after specialization, Ted will produce 16 units of corn per day and Jane will produce 2 units of potper day. Now one unit of pot will be exchanged for 8 units of Corn. It will benefit pot manufacturer more as he will get higher quantity of corn now. But in reality actual exchange rate will depend upon bargaining between the two. Ultimately exchage rate will be fixed in such a manner that both can get some banefits from specialization. .

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