Econo 101 Chapter 2

How does the theory of comparative advantage relate to production possibility curves?
Answer:
The theory of comparative advantage underlies the shape of the production possibility curve. As more and more of a good is produced, resources that have less of a comparative advantage are brought into the production of a good, causing the production possibility curve to be bowed outward.

If neither of two countries has a comparative advantage in either of two goods, what are the gains from trade?
Answer:
There are no gains from the trade.

Does the fact that the production possibilities model tells us that trade is good mean that in the real world free trade is necessarily the best policy? Explain.
Answer:
No, because the model does not take into account the importance of institutions and government in trade and takes no other societal goals into account besides maximum total output. These contexts should be taken into account when formulating policy.



What effect has globalization had on the ability of firms to specialize? How has this affected the competitive process?
Answer:
Globalization increases competition by allowing greater specialization and division of labor.

If workers in China and India become as productive as U.S. workers, what adjustments will allow the United States to regain its competitiveness
Answer:
It is possible that there will develop areas of production/services that will allow U.S. wages to remain high but in all likelihood either Western nominal wages will grow slowly and foreign nominal wages will grow rapidly and catch up or U.S. exchange rates will decline to equalize wages. Some combination of the two is most likely.

How can exchange rates change to reduce wage differences between countries?
Answer:
A fall in a country's exchange rate will lower its relative wage, and a rise in a country's exchange rate will raise its relative wage.

How is outsourcing related to the law of one price?
Answer:
Outsourcing is one of the mechanisms that maintain the law of one price, like free trade, low transportation costs, and peace.