The graph below represents the Production Possibilities Frontiers (PPFs) for two countries in an imaginary two-good world. Assume that Portugal and England have equal resource endowments. This is based on Ricardo’s original example. As an English gentleman, Ricardo assumed that Portugal was more efficient in the production of both wine and wool. He assumed that both countries had equal resource endowments, but differing production possibilities, with Portugal capable of producing more of both wine and wool.
1. Calculate the opportunity cost of wine in each country (specify the units):
England: ______Portugal: ______
2. Calculate the opportunity cost of wool in each country (specify the units):
England: ______Portugal: ______
3. Identify each country’s comparative advantage (wine or wool):
England: ______Portugal: ______
4. Assume that, before trade, England produces and consumes 400 pints of wine per year. Find the quantity of wool that will put England on its PPF. ______pounds of wool per year. Label this point Ae.
5. Assume that, before trade, Portugal produces and consumes 500 pints of wine per year. Find the quantity of wool that will put Portugal on its PPF. ______pounds of wool per year. Label this point Ap.
6. Before trade, world output equals ______pints of wine and ______pounds of wool per year.
7. Assume that each country specializes completely in the good in which it holds a comparative advantage. Label the point at which England will produce as E. Label the point at which Portugal will produce as P.
8. After specialization, world output equals ______pints of wine and ______pounds of wool per year.
9. Assume that the trade price of one pint of wine is 1.5 lb. of wool. Draw each country’s Consumption Possibility Frontier (CPF) on its graph below. Further assume that each country consumes 500 pints of wine after trade. Label the point at which each country consumes as C on its own graph.
10. Do both countries gain from trade? If so, how much does each gain? If not, what is lost?
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