Chapter 18, Problem 2.1P

Subpart (a):

To determine

The production possibility frontier.

Explanation of Solution

The production possibility frontier for country Latvia is given in figure 1 as follows:

From figure 1, it can be inferred that if all the resources are employed in the production of tractors then, at most 75,000 tractors can be produced and if all resources are employed in the production of Bobsleds then. 225,000 bobsleds can be produced.

The production possibility frontier for country Estonia is given in figure 2 as follows:

From figure 2, it can be inferred that if all the resources are employed in the production of tractors then, at most 37,500 tractors can be produced and if all resources are employed in the production of Bobsleds then. 75,000 bobsleds can be produced.

Economics Concept Introduction

Concept Introduction:

Production possibilities frontier: It is a graph that shows the combinations of output that the economy can possibly produce the given available factors of production and the available production technology.

Subpart (b):

To determine

The opportunity cost, comparative advantage, and trade.

Explanation of Solution

The opportunity cost of producing Tractors for Latvia (OC_LT) can be calculated as follows:

$\begin{array}{c}{\text{OC}}_{\text{LT}}=\frac{{\text{Output per worker in Latvia}}_{\text{Bobsleds}}}{{\text{Output per worker in Latvia}}_{\text{Tractor}}}\\ =\frac{225,000}{75,000}\\ =3\text{ Bobsleds}\end{array}$

Thus, the opportunity cost for Latvia to produce one tractor is 3 bobsleds.

The opportunity cost of producing Tractors for Estonia (OC_ET) can be calculated as follows:

$\begin{array}{c}{\text{OC}}_{\text{ET}}=\frac{{\text{Output per worker in Estonia}}_{\text{Bobsleds}}}{{\text{Output per worker in Estonia}}_{\text{Tractor}}}\\ =\frac{75,000}{37,500}\\ =2\text{ Bobsleds}\end{array}$

Thus, the opportunity cost for Estonia to produce one tractor is 2 bobsleds.

Since Estonia incurs a lower opportunity cost in the production of tractors then, Estonia has a comparative advantage in tractor production than Latvia.

The opportunity cost of producing Bobsleds for Latvia (OC_LB) can be calculated as follows:

$\begin{array}{c}{\text{OC}}_{\text{LB}}=\frac{{\text{Output per worker in Latvia}}_{\text{Tractor}}}{{\text{Output per worker in Latvia}}_{\text{Bobsleds}}}\\ =\frac{75,000}{225,000}\\ =\frac{1}{3}\text{ Tractors}\end{array}$

Thus, the opportunity cost for Latvia to produce one bobsled is 1/3 tractors.

The opportunity cost of producing Bobsleds for Estonia (OC_EB) can be calculated as follows:

$\begin{array}{c}{\text{OC}}_{\text{EB}}=\frac{{\text{Output per worker in Latvia}}_{\text{Tractor}}}{{\text{Output per worker in Latvia}}_{\text{Bobsleds}}}\\ =\frac{37,500}{75,000}\\ =\frac{1}{2}\text{ Tractors}\end{array}$

Thus, the opportunity cost for Estonia to produce one bobsled is 1/2 tractors.

Since Latvia incurs a lower opportunity cost in the production of bobsleds then, Latvia has a comparative advantage in bobsleds production than Estonia.

Since both have comparative advantages, they will definitely engage in the trade.

Economics Concept Introduction

Concept Introduction:

Opportunity cost: The opportunity cost refers to the value of what one has to give up in order to choose another alternative.

Comparative advantage: It is the ability of a producer, firm or country to produce a good or service at a lower opportunity cost of production than the competitors.

Subpart (c):

To determine

The agreement of exchange.

Explanation of Solution

If a trade’s agreement is negotiated, any agreement between 2 bobsleds and 3 bobsleds per tractor will benefit both countries’ trade and specialization.