Question

Consider two city-states: Gilead and Mahishmathi. They can produce two goods: gun- powder and maple syrup. In a single year, Gilead can make 1,000 tons of gunpower and 1,500 tons of maple syrup. In the same period of time, Mahishmathi can produce 2,000 tons of gunpowder and 1,500 tons of maple syrup.

Assume that both nations are productively efficient, and that they each have a constant Marginal Rate of Transformation. Initially, before trade, Gilead makes 750 tons of maple syrup, and Mahishmathi makes 750 tons of maple syrup.
Now they decide to trade. Which of the following is a beneficial trade for both nations?

(A) Gilead trades 100 tons of gunpowder for 200 tons of maple syrup.

(B) Gilead trades 100 tons of gunpowder for 175 tons of maple syrup.

(C) Gilead trades 100 tons of gunpowder for 125 tons of maple syrup.

(D) None of the above.

Can you please explain how you got the answer?

Answer 1

Given the production of maple and gunpowder, the comparative advantage analysis should be used wherein then product which has least opportunity cost should be produced.

Gilead can make either 1000 gunpowder or 1500 maple syrup. So opportunity cost of one gunpowder is 15/10=3/2 maple syrup and of 1 maple syrup is 2/3 gunpowder.

Similarly Mahismathi can produce either 2000 gunpowder or 1500 maple syrup.

So the opportunity cost of 1 gunpowder is 3/4 maple syrup and of 1 maple syrup is 4/3 gunpowder.

A comparison of these show that Mahismathi should produce gunpowder and Gilead should produce maple syrup.

Given this 2000 gunpowder and 1500 maple syrup would be produced.

Before trade both the countries were producing half of each good. So 1500 maple syrup and 1500 gunpowder were produced.

Now the trade of gunpowder and maple syrup would be between 750 maple syrup for anything between 500 to 1000 gunpowder. This is because Gilead was producing 500 gunpowder and Mahismathi was producing 1000 gunpowder. So anything between these before trade would be traded now.

If suppose 600 gunpowder is traded for 750 maple syrup, then the ratio would be the same as trading 100 gunpowder for 125 maple syrup. This was both the countries would be benefitted from trade.

So answer would be option C) Gilead trades 100 gunpowder for 125 maple syrup.