Gains from trade
Suppose Amy and Penny are housemates and there are two chores that need to be completed: cooking meals and laundry. Assume the hours needed to cook a meal or finish a basket of laundry are different for Amy and Penny and are described in the table below.
1 MEAL 1 BASKET
AMY 1/4 2
PENNY 1 4
1.1. What is the maximum number of meals and laundry baskets that Penny can produce in 12 hours?
What is the maximum number of meals and laundry baskets that Amy can produce in 12 hours?
1.2. Plot in a graph: Amy’s production possibility frontier. (4 points)
1.3. Plot in a graph: Penny’s production possibility frontier. (4 points)
1.4. What is Amy and Penny’s opportunity cost of producing one meal (in terms of baskets given up)?
What is their opportunity cost of producing one basket (in terms of meals given up)? (4 points)
1.5. Who has an absolute advantage in producing meals? Who has an absolute advantage in producing
laundry baskets? Explain your answer. (4 points)
1.6. Who has a comparative advantage in producing clean laundry baskets? Explain your answer.
1.7 What is the price range at which: (1) trade would occur between Amy and Penny, and (2) both Amy and Penny would be better off?
1.8. Suppose each person has 12 hours for the two tasks in a week and suppose both Amy and Penny each spend 8 hours on laundry and 4 hours on cooking. Assume also that they do not trade initially.
Suppose Amy then proposes to Penny that they specialize in what each one does relatively best and trade at a price of 1 basket of laundry for 6 meals. Will trade occur at this price? If so, can you find a production plan and proposed trade that would make both Penny and Amy better off relative to the initial production plan without trade? Hint: For a production plan, you need to specify how each person divides
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their 12 hours between the two tasks. The final allocation with trade benefits Amy and Penny when it
results in no fewer meals and no fewer baskets for either person.
