Question

In: Economics

Albert and Benjamin inhabit a two person world and they could only produce and consume two...

Albert and Benjamin inhabit a two person world and they could only produce and consume two goods: corn and sausage. They both face constant returns to scale. The table below shows the production possibilities for Albert and Benjamin if they are to fully specialize in each good only:

Albert Benjamin

Corn only 150 200

Sausage only 200 400

Originally Albert and Benjamin practices self-sufficiency and do not trade with each other. An economist proposes to Albert and Benjamin that they should end self-sufficiency and trade with each other. The economist proposes that Albert should specialize in sausage production and Benjamin should focus on corn production, and Albert should give Benjamin 100 sausage in exchange for 100 corn. Would the proposal make both Albert and Benjamin better off? Explain why yes or why not using the economic theories you have learnt?

Expert Solution

Answer to the question:

No. Albert has a comparative advantage on the production of corn and Benjamin has a comparative advantage on the production of Sausage. So, Albert will specialise and export Corn and Benjamin well specialise and export Sausage.

Explanation:

Albert can produce either 150 amount of Corn or 200 units of sausage. So, the cost of 150 corn for Albert is 200 Sausage. So, 1 unit of corn will cost 1.33 units of sausage (200/150). Similarly, 1 unit of sausage will cost 0.75 units of corn (150/200).

Benjamin can produce either 200 amount of Corn or 400 units of sausage. So, the cost of 200 corn for Benjamin is 400 Sausage. So, 1 unit of corn will cost 2 units of sausage (400/200). Similarly, 1 unit of sausage will cost 0.50 units of corn (200/400).

We can here see that the relative price of corn is less for Albert and the relative price for sausage is less for Benjamine. So, they will specialise and export the commodity in which they have a comparative cost advantage. So, Albert will produce and export Corn and Benjamine will produce and export Sausages.

For Albert, 1 unit of sausage costs 0.75 unit of Corn, so he will not pay Benjamin anything above 0.75 units of corn for each unit of sauage.

For Benjamin, 1 unit of sasage cost 0.50 unit of corn, so he will not accept anything less than 0.50 unit of corn for each unit of sausage.

So, the price of the sausage will lie between 0.50 unit and 0.75 unit of corn.

Suppose, the price is fixed at 0.50 corn=1 sausage, and Albert is producing only corn of 150 units. And Benjamine is producing only sausage of 400 units. If at this rate of exchange, Benjamin exports 200 units of sausage to the Albert, then he will give Benjamin 100 units of corn. So ultimately Benjamin will be having 200 units of sausage and 100 units of corn. On the other hand, Albert will be having 100 units of sausage and 50 units of corn. So the total world production will be 50+200+100+200=550. And both will be better off from this trade.

NOTE: (As suggested by the economist) If Albert specialises and export Sausage and Benjamine specialises and export Corn at a exchange rate of 1 corn = 1 sausage, then the tatol world production will be restricted at 400 units. So, it's not a better option.

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Rahul Sunny answered 2 years ago

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