Question

Consider two countries: Canada and Sri Lanka. Assume that each can produce only two goods: maple syrup and jaggery. In a single year, Canada can produce 250,000 tons of maple syrup, or 90,000 tons of jaggery. In the same period of time, Sri Lanka can produce 1,000 tons of maple syrup, or 70,000 tons of jaggery.

Suppose that both nations are initially in a state of autarky. If Canada were to produce 170,000 tons of maple syrup and 36,000 tons of jaggery, then this allocation would be:

(A) Feasible and productively efficient. (B) Feasible and productively inefficient. (C) Infeasible. (D) Like Saturdays: for the boys

Suppose that both nations are initially in a state of autarky. If Sri Lanka were to produce 300 tons of maple syrup and 49,000 tons of jaggery, then this allocation would be:

(A) Feasible and productively efficient. (B) Feasible and productively inefficient. (C) Infeasible. (D) Built different.

Assume that both nations are productively efficient. Initially, before trade, Canada makes 125,000 tons of maple syrups and 45,000 tons of jaggery. Sri Lanka makes 200 tons of maple syrups and 56,000 tons of jaggery. Now they decide to trade. Which of the following is a beneficial trade for both nations?

(A) Canada gives Sri Lanka 1,000 tons of maple syrup in exchange for 1,000 tons of jaggery. (B) Canada gives Sri Lanka 3,000 tons of maple syrup in exchange for 1,000 tons of jaggery. (C) Canada gives Sri Lanka 6,000 tons of maple syrup in exchange for 1,500 tons of jaggery. (D) None of the above.

If each country were to specialize in the goods for which they have comparative advantage, how much would each produce?

(A) Canada would produce 250,000 tons of maple syrup, and Sri Lanka would produce 70,000 tons of jaggery. (B) Canada would produce 250,000 tons of maple syrup, and Sri Lanka would produce 1,000 tons of maple syrups. (C) Canada would produce 90,000 tons of jaggery, and Sri Lanka would produce 1,000 tons of maple syrup. (D) Canada would produce 90,000 tons of jaggery, and Sri Lanka would produce 70,000 tons of jaggery.

Answer 1

Given:

The maximum production possibilities of Canada and Sri Lanka when they allot all resources into producing only one.

Therefore the production possibility frontier of each;

Production possibility frontier shows all the combination of two goods (here, Syrup and Jaggery) that can be produced with the given resources and technology. The points on the PPF shows the optimum and fullest utilization of the resources. The combination inside the PPF shows the inefficient utilization of resources. And the points outside the PPF are unattainable for the economy.

1.) If Canada were to produce 170,000 tons of maple syrup and 36,000 tons of jaggery, then this allocation would be:

Answer: (C) Infeasible

The combination is: (170000 Maple syrup, 36000 jaggery)

Putting maple syrup on the x axis and jaggery on the y axis.

And the intersepts of the line is the maximum potential of Canada

x-intercept = maximum potential to produce maple syrup = 250000 tons

y-intercept = maximum potential to produce jaggery = 90000 tons

The canada's production possibility frontier is:

As the Canada were to produce (170000,36000), this combination of the two goods lies outside Canada's PPF. Therefore this combination is unattainable. Canada cannot produce 170000 maple syrup with 36000 jaggery with the given resources and technology.

Therefore at this allocation for Canada would be infeasible.

2.) If Sri Lanka were to produce 300 tons of maple syrup and 49,000 tons of jaggery, then this allocation would be:

Answer (A) Feasible and productively efficient.

The combination given is (300 maple syrup, 49000 jaggeries)

Since the production function of sri lanks is: Putting maple syrup on the x axis and jaggery on the y axis. And the intercepts of the line is the maximum potential of Sri Lanka.

x-intercept = maximum potential to produce maple syrup = 1000 tons

y-intercept = maximum potential to produce jaggery = 70000 tons

As the point or combination (300,49000) lies on the PPF, therefore at this point Sri Lanka is not producing at the feasible point. A feasible point is one that a country can produce on. But it is only producing at the an efficient point. As the points on the PPF shows all the productively efficient points.

Therefore at this allocation for Sri- Lanka would be: feasible and productively efficient.

3.) Both nations are producing at productively efficient. Both countries produces:

Now in order to find a beneficial trade agreement, we have to find the opportunity costs. That will decide the beneficial trade relative prices.

Opportunity cost is the amount of one good forgone to gain one more unit of another.

Opportunity cost = Good sacrificed/Good gained

Terms of trade will be dependent on comparative advantages. That is, which country can produce the good at a lower opportunity cost.

Since, here Canada can produce maple syrup at a lower opportunity cost, therefore it will trade maple syrup. And since Sri Lanka has a lower opportunity cost in producing Jaggery, therefore it will trade its jaggery.

So it is clear that Canada will trade maple syrup for jaggery. Or we can say that Sri Lanka will trade jaggery for maple syrup.

The trade will be beneficial when the trade is according to their relative prices.

That is,

Since relative price of maple syrup is:

For Canada = 0.036 Jaggery

And the relative price of jaggery is:

For sri lanka = 0.005 ton of maple syrup

The relative price is set such that both gain from trade.

Canada will trade its maple syrup for a relative price of more than 0.036 jaggery

and sri lanka will trade its jaggery for a relative price more than 0.005 maple syrup

Only option 1 satisfies this condition.

Where Canada gives 1000 ton of maple syrup in exchange for 1000 ton of jaggery.

As we can verify that in this trade terms:

Relative price of maple syrup = 1000/1000 = 1 ton of jaggery

Relative price of jaggery = 1000/1000 = 1 ton of maple syrup

As the trade prices must be more than autarky prices for the countries to gain.

1>0.36 (Relative price of maple syrup)

1>0.005 (Relative price of jaggery)

Therefore,

Answer (A) Canada gives Sri Lanka 1,000 tons of maple syrup in exchange for 1,000 tons of jaggery.

Why other options are not correct:

Option (B): Canada gives Sri Lanka 3,000 tons of maple syrup in exchange for 1,000 tons of jaggery

Relative prices of maple syrup is =1000/3000 = 0.33 jaggery which is less than the Canada's relative price. So Canada will not trade at this price. It is incorrect.

C) Canada gives Sri Lanka 6,000 tons of maple syrup in exchange for 1,500 tons of jaggery:

Relative price of maple syrup = 1500/6000 = 0.25 ton of jaggery which is less than the Canada's relative price. So Canada will not trade at this price. It is incorrect.

D.) None of the above: As option A is correct, therefore is incorrect.

Therefore option (A) is correct.

4.) When both the countries specialises in the product that they have a comparative advantage in. Comparative advantage is when countries produce only the good that they have a lower opportunity cost in.

As we have discussed that,

Canada has a lower opportunity cost in producing maple syrup and Sri Lanka has a lower opportunity cost in producing jaggery. Therefore they will produce the respective goods to their fullest capacity.

Canada will produce maple syrup.

Sri Lanka will produce jaggery

They will produce the maximum quantity that they could produce when they produce only one.

When they both specialises and produces the good that they have a comparative advantage in.

Answer (A) Canada would produce 250,000 tons of maple syrup, and Sri Lanka would produce 70,000 tons of jaggery.