Question

There are two countries, Lilliput and Blefuscu, which produce two goods: cilantro and hummus. In a single year, Lilliput can produce 4,000 tons of cilantro or 4,000 tons of hummus. In the same period of time, Blefescu can produce 500 tons of cilantro or 300 tons of hummus. Show your work as you answer these questions. (e) Prior to trade, Lilliput makes 2,000 tons of cilantro, and Blefuscu makes 300 tons of cilantro. Draw these allocations on separate Production Possibilities Frontiers for each country. (10%) (f) Considering the situation in (e), suppose that Lilliput gives Blefuscu 50 tons of hummus in exchange for 60 tons of cilantro. Is this a beneficial trade for both 1 countries? Use PPF diagrams to argue why or why not. (15%) (g) Again considering the example in (e), what would be an example of a non-beneficial trade between the two countries? Show your work. (15%)

Answer 1

(e)

Before trade Lilliput was producing 2000 cilantro and 2000 Hummus(Because his opportunity cost of producing Hummus is 1 cilantro, if it is sacrificing production of 2000 cilantro, it can produce 2000 Hummus).

Similarly, Blefuscu is producing 300 cilantro and 120 Hummus(because its opportunity cost of producing Hummus is 5 cilantro for 3 hummus, i.e. if it is sacrificing production of 200 cilantro, it can produce, 200*3/5= 120 Hummus).

PPC curve for both countries are as follows:

(f) Considering the situation in (e) Blefuscu has to sacrifice 50*5/3=83.33 tons of cilantro for the production of 50 tons of hummus. Therefore if Lilliput trades 60 tons of cilantro against 50 tons of hummus then the trade is beneficial for Blefuscu and also for Lilliput because Lilliput could have produced 50 tons of cilantro by sacrificing production of 50 Hummus.

After trade if Lilliput will produce only 4000 hummus and trade 50 hummus for 60 cilantro, then maximum it can get is 4800 cilantro. similarly if Blefusu will produce only cilantro and will trade it for hummus maximum hummus it will be able to get will be 416.66.

After trade Production possibility frontiers are as follows:

It can be seen in the figures that after trade both nations have their Production possibility frontiers to the right showing that now they can get more and are benefitting from trade.

(g)

If Lilliput would have traded 50 tons of Hummus for 90 tons of cilantro then this trade would have been non-beneficial for Blefuscu and if Lilliput would have traded 50 tons of Hummus for 40 tons of cilantro then this trade would have been non-beneficial for Lilliput.

Blefuscu can produce 50*5/3=83.33 units of cilantro by sacrificing 50 tons of Hummus. If it will have to give 90 tons of cilantro for 50 tons of hummus. Then trade will be non-beneficial.