Question

Suppose Russia and Sweden each produce only paper and cars. Russia can produce 8 tons of paper or 4 million cars each year. Sweden can produce 25 tons of paper or 5 million cars each year. \(\left[\mathrm{LO}_{2.4}\right]\) a. Draw the production possibilities frontier for each country. b. Both countries want 2 million cars each year and as much paper as they can produce along with 2 million cars. Find this point on each production possibilities frontier and label it "A." c. Suppose the countries specialize. Which country will produce cars? d. Once they specialize, suppose they work out a trade of 2 million cars for 6 tons of paper. Find the new consumption point for each country and label it "B."

Short answer

Russia should specialize in cars, and after trade, Russia will consume 2 million cars and 6 tons of paper, while Sweden will consume 3 million cars and 19 tons of paper.

Step-by-step solution

Understanding Production Capabilities

Russia can either produce 8 tons of paper or 4 million cars in a year, and Sweden can produce either 25 tons of paper or 5 million cars per year. Therefore, their production possibilities are linear relationships between these outputs due to constant opportunity costs.

Drawing the Production Possibilities Frontiers (PPFs)

Russia's PPF is a straight line from 8 tons of paper on one axis to 4 million cars on the other. Sweden's PPF is a straight line from 25 tons of paper on one axis to 5 million cars on the other. Both graphs illustrate the trade-off between cars and paper for each country.

Finding Point 'A' on PPFs

Each country wants 2 million cars. For Russia, this corresponds to remaining resources for 4 tons of paper (since producing 2 million cars means producing half their max, allowing for half the paper, i.e., 4 tons). For Sweden, this corresponds to 15 tons of paper (3 million cars-worth resources left means 15 tons of paper). Mark these as Point 'A'.

Identify Comparative Advantage for Specialization

Russia's opportunity cost of producing 1 car is 2 tons of paper (8/4). Sweden's is 5 tons of paper (25/5). Russia has a lower opportunity cost for cars, hence it should specialize in cars. Sweden has a comparative advantage in paper production.

Find New Consumption Point After Trade (Point 'B')

After specialization, Russia produces 4 million cars (0 tons of paper) and Sweden produces 25 tons of paper (0 cars). Trading 2 million cars from Russia for 6 tons of paper from Sweden, Russia now consumes 2 million cars and 6 tons of paper, and Sweden consumes 3 million cars and 19 tons of paper. These new consumption points should be marked as 'B' for each country.

Key concepts

Comparative Advantage

Comparative advantage is a vital concept in understanding international trade and the benefits of specialization. It refers to the ability of a country to produce a specific good or service at a lower opportunity cost than its trading partners. In the exercise given, Russia and Sweden each produce paper and cars, but at different efficiencies. Russia can produce 8 tons of paper or 4 million cars per year, while Sweden can produce 25 tons of paper or 5 million cars annually. For Russia, the opportunity cost of producing 1 car is 2 tons of paper. In contrast, Sweden's opportunity cost of producing 1 car is 5 tons of paper.

• Russia's opportunity cost for car production is lower than Sweden's, giving it a comparative advantage in cars.
• Sweden has a comparative advantage in producing paper because it sacrifices fewer cars to produce paper than Russia would.

By each country focusing on producing the good for which it has a comparative advantage, both nations can trade and benefit more than if they tried to produce both goods themselves.

Opportunity Cost

Opportunity cost is a crucial concept in economics, referring to the value of the next best alternative foregone when making a decision. It helps explain the trade-offs each country faces when choosing how much of a good to produce. In this scenario, Russia's opportunity cost of producing a car is 2 tons of paper, calculated by dividing the maximum production of paper (8 tons) by the maximum production of cars (4 million). Conversely, Sweden's opportunity cost of producing a car is 5 tons of paper, as it has to forego producing that amount to make one car.

• Opportunity cost helps decide which good a country should specialize in.
• Russia should produce cars because it gives up less in terms of paper production compared to Sweden.

Understanding opportunity cost enables countries to allocate resources efficiently and achieve maximum gains from trade.

Specialization

Specialization involves focusing resources on the production of specific goods that a country can produce most efficiently. This means harnessing comparative advantage to maximize output. In the scenario, when Russia and Sweden analyze their opportunity costs, they find which products they produce relatively more efficiently. Russia specializes in cars due to its lower opportunity cost. Meanwhile, Sweden focuses on paper production due to its comparative advantage in this area.

• By specializing, countries increase their overall production capacity.
• Specialization allows each country to produce beyond its previous limits when considering consumption possibilities.

Through specialization, each country can trade the surplus of their specialized goods, improving consumption beyond self-sufficiency.

Trade and Consumption

Trade opens up new opportunities for countries to consume more than they could individually produce using their resources. Once Russia and Sweden specialize based on their comparative advantages, they can engage in trade to maximize their consumption. In the exercise, Russia trades 2 million cars for 6 tons of paper with Sweden.

• Post-trade, Russia consumes 2 million cars and 6 tons of paper.
• Sweden ends up with 3 million cars and 19 tons of paper.

Through trade, each country moves from point 'A' to point 'B' on their production possibilities frontier, accessing a combination of goods they otherwise couldn't produce on their own.

Microeconomics

Microeconomics is the study of individual agents and markets, focusing on how they make decisions and allocate resources. This exercise showcases several microeconomic principles, such as production possibilities, opportunity cost, and the benefits of trade. By examining the decision-making processes of Russia and Sweden in allocating resources between paper and car production, we learn how microeconomic concepts like comparative advantage steer specialization and trade.

• Microeconomics helps explain market behaviors based on individual decision factors.
• Understanding opportunity costs can help optimize resource allocation and production efficiency.

This foundational understanding allows countries to strategically decide on production and trade, achieving better economic outcomes.