ECO10004 Economic Principles

Answer the following questions from Table 1-1 – must show workings

1.1a.Which country has an absolute advantage in the production of motorcycles?

2.1b.Which country has an absolute advantage in the production of guitars?

3.1c.What is Ireland's opportunity cost of producing one motorcycle?

4.1d.What is Scotland's opportunity cost of producing one motorcycle?

5.1e.What is Ireland's opportunity cost of producing one guitar?

6.1f.What is Scotland's opportunity cost of producing one guitar?

7.1g.If each country specialises in the production of the product in which it has a comparative advantage, who should produce motorcycles?

8.1h.If each country specialises in the production of the product in which it has a comparative advantage, who should produce guitars?

2.Define the concept of efficiency. Define the concept of equity. Using the tax system as an example to explain how a trade-off exists between economic efficiency and equity.

TASK 1: Economic Foundations and Market Forces

1.    (a)   As we see from the data given in the table, Scotland takes less time in producing a motorcycle as well as a guitar than Ireland, i.e., 9 hours to produce 1 motorcycle where Ireland needs 10 hours to do the same. Hence, Scotland is the country that has an absolute advantage in production of motorcycle.

(b)  The time taken by Scotland in production of a guitar is 2 hours compared to 2.5 hours taken by Ireland. Since it takes less time, the country that has an absolute advantage in producing guitars is Scotland.

(c)  Ireland takes 2.5 hours to produce a guitar and 10 hours to produce a motorcycle. Therefore, the 10 hours needed for Ireland to produce one motorcycle, it can produce:
{(1/2.5)*10}= 4 guitars, in the same time. Hence the opportunity cost of Ireland in the production of one motorcycle is 4 guitars.

(d)  The time taken by Scotland to produce a motorcycle is 9 hours whereas to produce a guitar takes 2 hours. In the 9 hours it produces a motorcycle, it can produce:
{(1/2)*9}= 4.5 guitars. Hence the opportunity cost of Scotland in production of one motorcycle is 4 guitars and a half.

(e)  Ireland takes 2.5 hours to produce a guitar and 10 hours to produce a motorcycle. Hence in those 2.5 hours, it can produce:
{(1/10)*2.5} = 0.25 part of a motorcycle. Opportunity cost of Ireland in producing a guitar is 0.25 motorcycle or can be said (1/4)th part of a motorcycle.

(f)   Scotland produces a guitar in 2 hours and a motorcycle in 9 hours. Hence in those 2 hours, it can produce:
{(1/9)*2} = 0.22 part of a motorcycle. Opportunity cost of Scotland in producing a guitar is 0.22 motorcycles.

(g) As we see from the above calculations, for producing a motorcycle Ireland’s opportunity cost is 4 guitars whereas for Scotland opportunity cost is 4.5 guitars. Therefore, Ireland has a comparative advantage in producing motorcycles and so it will specialize in producing the same.

(h) Scotland faces an opportunity cost of 0.22 part of a motorcycle in producing a guitar whereas Ireland faces a higher opportunity cost of 0.25 part of a motorcycle. Therefore, Scotland has a comparative advantage in producing guitars and shall specialize to produce the same. (Boundless.com)

2.    The optimal production as well as allocation of resources given the existing limited factors of production is known as efficiency. Equity is about how the various resources are distributed throughout the society (Mankiw, 2007).
Equity efficiency trade off is seen when any kind of activity in the market increases in efficiency but lacks equity. Equity efficiency trade off is artificially introduced in a market when one is concerned with the distribution of resources to be more equal but would limiting productive efficiency (Mankiw, 2007).
The trade off can be explained with the help of a tax system for instance the Communal charge or poll tax system. Such a system of tax helps in not distorting economic behavior in other words not reducing the incentives to work, hence reflecting efficiency. But a millionaire paying the same amount of tax as a poor person pays is socially unfair and hence trading off equity (Pettinger, 2010).