Intro Macro Tutorial 9 (Week 10)

James Hutcheon, Semester 2 2019

 Solutions posted here: facebook.com/groups/ucmacro2019

Review Questions
 Describe the convergence theorem and in what circumstances the Solow Swan model
supports it.
o The convergence theorem suggests that all economies are slowly converging to the
same steady state output per worker, and any difference is caused just by different
‘starting conditions’.
o The Solow Swan model supports something called ‘Conditional Convergence’. Only if
countries have similar population growth, savings rates, depreciation rates and
technology levels will they converge. Otherwise, they will be moving to different
steady states.
 Describe the principle of growth accounting. Describe the components of the following
equation. Why is productivity growth otherwise known as the ‘Solow residual’?
rk wl ^
Y^ = ^
A+ k^ + l
Af (k , l) Af ( k ,l)
o Breaking down of output growth into factors like TFP growth, capital growth and
labour growth.
o The factors in front of the capital and labour growth rates are the capital share of
output and the labour share of output – i.e. how important they are to the level of
output.
o Productivity growth is a residual term – it explains growth not associated with
growth in labour or capital, i.e. not explained by the Solow-Swan model.
 Describe the differences between an endowment and a production economy. How do they
influence international trade?
o Endowment economies start with an initial endowment of goods. Countries can
trade these goods to satisfy their demands, but cannot use those goods as inputs to
produce new goods.
o Production economies start with an amount of resources they can use to produce
goods. Countries can choose to produce just for themselves, or to produce the things
they’re good at, and then trade excess to another country.
 What is the difference between absolute advantage and comparative advantage?
o A country has an absolute advantage if they can produce more of good A with a
given amount of resources than the other country can.
o A country has a comparative advantage if the opportunity cost of producing good A,
in terms of amount of good B given up, is lower than the other country.
o For example, let’s say China can produce 100 tonnes of steel per hour, but they can
alternatively produce 500 tonnes of coal. Australia can only produce 50 tonnes of
steel per hour or 100 tonnes of coal. China has an absolute advantage in coal and
steel over Australia. However, 1 tonne of steel in China means giving up 5 tonnes of
coal, while 1 tonne of steel in Australia only means giving up 2 tonnes of coal. So
Australia has a comparative advantage in steel.
 Why are production possibility frontiers for a country concave? What might cause the PPF
to move inward or outward?
o Not all workers in an economy are equally as good at producing each good. If a
country overspecialises, they are causing some workers to do a job they aren’t
efficient at.
Questions
1. (BOF) Suppose that two countries, Australia and Venezuela, can produce only two goods,
cotton and pineapples. It costs Australia 1 unit of labour to produce a bale of cotton, and 2
units to produce a pineapple. It costs Venezuela 4 units of labour to produce a bale of
cotton, and 3 units to produce a bale of cotton.
a. Does either economy have any absolute advantages?
A: Australia has an absolute advantage in both cotton and pineapples.
b. Find the opportunity costs for both countries to produce 1 unit of cotton, and also to
produce 1 pineapple, in terms of the other good.
A:

Cotton Pineapples
Australia 0.5 pineapples 2 units of
cotton
Venezuela 1.33 0.75 units of
pineapples cotton
c. In which commodity does each country have a comparative advantage?
A: Australia has a comparative advantage in cotton, while Venezuela has the
comparative advantage in pineapples.
d. Assume that Australia and Venezuela have 60 units of labour each. A possible
allocation of production is as follows:

Cotton Pineapples
Australia 30 15
Venezuela 12.5 3.33
How many workers are allocated to the respective industries in each country?
A: In Australia, we must have 30 workers in each industry. In Venezuela, we must
have 50 cotton workers and 10 pineapple workers.
e. Show that if both countries specialises in the production of the commodity they
have a comparative advantage for, total output of both goods could be increased.
A: If all Australian workers focus on cotton, they would produce 60 bales. If all
Venezuelan workers focus on pineapples, they would produce 20 pineapples. Total
output is 60 bales of cotton and 20 pineapples, both of which are greater than the
above levels.
f. Show using diagrams that if (i) the countries specialised according to the law of
comparative advantage, and (ii) the countries could trade at a price of one pineapple
equals one bale of cotton, that the citizens of both countries would be better off
relative to the situation in which production was not specialised and trade did not
occur.
A: The diagrams (one for each country) should show the possible allocations
without trade, and the possible allocations if the countries specialise. All allocations
on the later line should be larger than the former. More is better!