Nation A can produce with one worker per day 10 cakes or 5 pizzas. Nation B...

Nation A can produce with one worker per day 10 cakes or 5 pizzas.

Nation B can produce with one worker per day 8 cakes or 2 pizzas.

i. Determine a trade agreement for 1 pizza (price in terms of x number of cakes for 1 pizza) that both countries would benefit from. (Do not give me a range of prices. Just give me one price and one price only.) (Hint: who will be buying and who will be selling pizzas?)

j. Explain (using numbers) how Nation A would benefit from your answer to (i) above.

k. Explain (using numbers) how Nation B would benefit from your answer to (i) above.

Solutions

Expert Solution

We'll decide which nation would specialize in which unit by following their opportunity cost.

For Nation A,

Opportunity cost of Cakes = 5/10 = 1/2 pizza per cake

Opportunity cost of Pizzas = 10/5 = 2 cakes per pizza

For Nation B,

Opportunity cost of Cakes = 2/8 = 1/4 pizza per cake

Opportunity cost of Pizzas = 8/2 = 4 cakes per pizza

Hence,

we can see that OC for pizza is lower for Nation A and OC for cake is lower for Nation B.

Hence, Nation A would make Pizzas and Nation B would make Cakes

Now,

The price for Pizza would be based on the Opportunity costs in both nations. Agreed price should be in between the Opportunity costs.

Hence, the agreed price for one pizza should be 3 cakes. ( just in between the two OCs)

j) Note that for the above-agreed price of 3 cakes per pizza, Nation A would get 3 cakes per pizza. If they had made cakes they would have got only 2 cakes per pizza. Hence, they are getting benefitted by one cake per pizza.

k)Note that for the above-agreed price of 3 cakes per pizza, Nation B would get 1/3 pizza per cake. If they had made pizzas as well, then they would have got only 1/3 pizza per cake. Hence, they are getting benefitted by (1/2-1/3= 1/6) pizza per cake.

Rahul Sunny answered 3 months ago

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