Exercises 1

 (i) Pareto optimum

A) In the following, you will find several statements. Decide whether these statements are correct or not.

 Q1: A Pareto optimal resource allocation refers to a situation where there is no room for improving someone’s position (utility level) without causing a deterioration in some other person’s net wealth position at the same time. CORRECT

Q2: A Pareto optimal allocation assumes the perfect functioning of the competitive market economy. CORRECt

Q3: A Pareto optimum has been achieved if it is not possible to improve agent A’s welfare when agent B is relatively poor. INCORRECT because a Pareto optimum has been achieved when it is impossible to improve agent A’s welfare without making agent B’s welfare position worse.

Q4: The first basic theorem of welfare economics does not say anything about the desirabilityof a Pareto optimal resource allocation. CORRECt

Q5: A Pareto optimal allocation can occur even in the presence of an extremely unequal distribution of goods. CORRECt

(ii) Comparative advantage

B) The biography has elaborated on an important political event that had a strong influence oneconomic issues as well. In Great Britain, a serious debate evolved around the so-called Corn Laws, which regulated the international trade (export and import) of grain. The following questions will address this specific economic and political situation.

Q1: Why did David Ricardo publish his “Essay on the influence of a low price of corn on the profits of stock” in 1815 (and not before or after that year)?

(a) The tariff increase induced a rise in the rents of country gentlemen, thereby lowering the profits of industry men.

(b) The increase of the power of Great Britain induced the decline in the rents of country gentlemen, thereby lowering the profits of industry men.

(c) The increase of the power of Great Britain induced the decline in the rents of industry men, thereby increasing the profits of country men.

(d) The tariff decline induced a rise in the rents of country gentlemen, thereby increasing the profits of industry men.

 

Q2: Was the reduced profitability of manufacturers a real problem in Great Britain almost 200 years ago?

(a) No, because it was the manufacturers who initiated investments and thereby economic growth in the British economy.

(b) No, because it was the countrymen who saved and invested, and thereby induced economic growth in Britain.

(c) Yes, because it was the countrymen who created savings and investments and enforced economic growth in the British economy.

(d) Yes, because it was the manufacturers who initiated investments and enforced economic growth in the British economy.

 

 

C) In the following, you will find several statements. Decide whether these statements are correct or not.

Q1: Unfortunately, the principle of comparative advantage is rather counter-intuitive. CORRECT

Q2: Talking about comparative advantage means that only one country (out of the two) has got an absolute advantage in the production of both goods. CORRECT

Q3: Talking about comparative advantage means that both countries should necessarily be more productive in both goods. INCORRECT (because it can be the case that one country is less productive in the production of both products)

 

Q4: If country A can produce product X at lower cost than country B, and if country B can produce product Y at a lower cost than country A, then country A will specialise in the production of product X, while country B will specialise in the production of product Y. This way both countries may gain from international trade. CORRECT

Q5: The pervious situation (Q4) was a nice example of comparative advantage theory. INCORRECT (because it was a situation of absolute advantage)

Q6: In Ricardo’s concrete example the two countries were Portugal and England and the two goods were cloth and wine. He found that if Portugal were twice as productive in cloth production relative to England but four times as productive in wine, then Portugal’s comparative advantage is in cloth, the good in which its productivity lead is greater. INCORRECT (because if Portugal were twice as productive in cloth production relative to England but four times as productive in wine, then Portugal’s comparative advantage lies in wine, since its productivity advantage is much greater in the latter one)

 

Q7: In its simplest form, comparative advantage means the larger absolute advantage or the smaller absolute disadvantage. CORRECT

 

Numerical example

D) Please look at the following table where numbers refer to productivity (number of items produced by one labour hour, e.g. 15 means that Germany is able to produce 15 pieces of cars in one hour).

 

Table: Labour productivity in Germany and Hungary

	Cars	Cloth
Germany	15	5
Hungary	6	3

 

Q1: Which of the two countries has an absolute advantage in the production of cars?

(a) Germany

(b) Hungary

(c) both

(d) none

 

Q2: Which of the two countries has an absolute advantage in the production of cloth?

(a) Germany

(b) Hungary

(c) both

(d) none

 

Q3: Based on the concept of absolute advantage, is there a chance for mutually beneficial trade between the two nations?

(a) No, since Germany is the best performing country in the production of both products.

(b) It depends on the wish of the countries.

(c) Yes, since Germany is the best performing country in the production of both products

(d) Yes, since Germany is much better in the production of cars, while Hungary is still good in the production of cloth.

 

Q4: Which of the two countries has a comparative advantage in the production of cloth?

(a) Germany

(b) Hungary

(c) both

(d) none

 

Q5: Which of the two countries has a comparative advantage in the production of cars?

(a) Germany

(b) Hungary

(c) both

(d) none

 

Q6: Based on the concept of comparative advantage, is there a chance for trade between the two nations?

(a) Yes, since Germany has a larger absolute advantage in the production of cloth, while Hungary has a smaller absolute disadvantage in the production of cars.

(b) No, since Germany is the best performing country in the production of both products.

(c) Yes, since Germany has a larger absolute advantage in the production of cars, while Hungary has a smaller absolute disadvantage in the production of cloth.

(d) Yes, since Germany is much better in the production of cars, while Hungary is still good in the production of cloth.