Mary produces both hats and apple pies:
• If Mary uses all her resources to produce hats, she can produce 48 hats an hour.
• If she uses all her resources to produce apple pies, she can make 24 apple pies an hour.
Bill produces both hats and apple pies.
• If Bill uses all his resources to produce hats, he can produce 24 hats an hour.
• If he uses all his resources to produce apple pies, he can make 48 apple pies an hour.
To complete this assignment, you must answer all of the following questions and complete all of the following activities:
1. Construct Mary’s production possibilities frontier and Bill’s production possibilities frontier. Plot hats on the vertical axis.
2. What is Mary’s opportunity cost of producing one apple pie?
3. What is Mary’s opportunity cost of producing one hat?
4. What is Bill’s opportunity cost of producing one apple pie?
5. What is Bill’s opportunity cost of producing one hat?
6. In which of the two activities does Mary have a comparative advantage? In which of the two activities does Bill have a comparative advantage? Explain your reasoning.
7. Suppose Mary and Bill are each producing 16 apple pies and 16 hats. Indicate this point on your production possibilities diagram.
8. Let Mary and Bill specialize in what they each have a comparative advantage in. Indicate these two points on your production possibilities diagram. What has happened to the total amount of hats and apple pies being produced? Explain why this happened.
9. Assume that both parties specialize in producing the good in which they have a comparative advantage. If Mary and Bill are willing to trade at the rate of one hat for one apple pie, and make a trade of 24 hats for 24 apple pies, demonstrate on your production possibilities diagram that both Mary and Bill can get outside of their individual production possibilities frontier. Why does this mean that both Mary and Bill are better off?
10. Use Mary’s opportunity costs and Bill’s opportunity costs to explain why the terms of trade of one hat for one apple pie was a good terms of trade for both of them.
11. Assume that both parties specialize in producing the good in which they have a comparative advantage. Would two hats for one apple pie be a good terms of trade for both Mary and Bill? Explain why or why not.
12. Assume that both parties specialize in producing the good in which they have a comparative advantage. Use Mary’s opportunity costs and Bill’s opportunity costs to find a range for the terms of trade that would be good for both Mary and Bill.
13. If Mary and Bill were Nation A and Nation B instead, the same principles of comparative advantage, specialization, and the benefits of trade would apply. If nations specialize in an area of comparative advantage and then trade with other nations who have specialized in areas of their comparative advantage, what will happen to the wealth of the trading nations? What could happen to the standard of living of the citizens of the nations? Why?