Countries face trade-offs between producing consumer goods and producing capital goods.

(a) Country A takes one hour to produce a unit of consumer goods and two hours to produce a unit of capital goods. Country Y takes two hours to produce a unit of consumer goods and three hours to produce a unit of capital goods. Which country has a comparative advantage in the production of consumer goods? Which country has an absolute advantage? Explain.

(b) If the two countries trade capital goods for consumer goods, which country will produce capital goods and which country will produce consumer goods? Explain.

(c) Draw a correctly labeled graph of the production possibilities curve for Country Y, with consumer goods on the horizontal axis and capital goods on the vertical axis.

(d) If the savings rate in Country Y goes up, causing consumer goods production to go down by the same amount that capital goods production goes up, what will be the effect upon the future growth rate of Country Y? Explain.

(e) Explain how an increase in net investment in capital stock will affect each of the following:

i. Aggregate demand iii. Long-run aggregate supply iv. Output (short run and long run)