Question 4

John and Sotiris live on trees in two different forests. They each have eight hours to work in a day. John can grow a Yam in 1 hour or raise a Zebra in 2 hours. Sotiris can grow a Yam in 2 hours or raise a Zebra in 4 hours. Both John and Sotiris consume equal numbers of Yams and Zebras.

(a)Clearly draw and label PPFs for John and Sotiris and their consumption bundle in autarky, with Zebras on the vertical axis, showing how you calculated this. Define and find the opportunity cost of a yam on each island and discuss how it can be represented on each PPF. Does John or Sotiris have an absolute or comparative advantage in producing either Yams or Zebras? (5 marks)

(b)Now suppose John and Sotiris can freely trade at a price of one Yam per Zebra. How much of each good will John and Sotiris produce and consume? How much better or worse off in percentage terms are John and Sotiris? How is this possible? (5 marks)

(c) In class, we have seen that free exchange under perfect competition can mutually benefit both consumers and producers. In words, briefly explain how this is possible. Then clearly list five situations that free exchange can hurt consumers or producers and an assumption about perfect competition that situation violates. (10 marks)

(d)When calculating the welfare benefits of markets, the standard analysis only includes the parties involved in exchange. Using the American Opioid Crisis as an example, explain how poorly regulated markets can cause harm to third parties not involved in exchange. (5 marks)