Question

5. Answer the questions below on the basis of the following production possibilities data for Flotsam and Jetsam. All data are in tonnes.

FLOTSAM PRODUCTION POSSIBILITIES:

	A	B	C	D	E
Pants	60	45	30	15	0
Shirts	0	15	30	45	60

JETSAM PRODUCTION POSSIBILITIES:

	A	B	C	D	E
Pants	20	15	10	5	0
Shirts	0	15	30	45	60

a. Give any five reasons why trade should take place.

b. If trade occurs between Flotsam and Jetsam, what will each country export, and why? Be sure to show clearly any working.

c. What is an acceptable term of trade for Flotsam and Jetsam? Explain.

d. Assume that prior to specialization and trade, Flotsam and Jetsam chose production possibility “B.” Now that each country specializes, what will be the resulting gains from specialization and trade in this case?

e. Why are gains from trade possible?

Answer 1

The five reasons for trade are as mentioned below-

1. Efficient allocation of resources
2. Lower cost to consumer
3. Innovation and technological development
4. Economies of scale
5. Breaks monopolies

b.Flotsam Opportunity cost for manufacturing of Pant=change in shirt across possibility frontier/change in pant manufacturing bacross possibility frontier=(15-0)/(60-45)=1Shirt similarly opportunity cost for shirt =1 Pant

ForJesam opportunity cost of manufacturing pant=(15-0)/(20-15)=3 shirt similarly for Shirt=(20-15)/(15-0)=1/3=0.33 since Flotsam has lower opportunity cost for manufacturing of Pant,Flotsam will export Pant and similarly Jesan Shirt

c. We can have term of trade in between opportunity cost of Jetsam and Flotsam which is for pant average of 1 and 3 shirt i.e 2 shirt which will be beneficial for Flotsam to trade pant as it will gain 2 shirt for each Pant traded which is better than its opportunity cost similarly for Jetsam trading 2 shirt for each Pant is better than its own opportunity cost of 3 shirt Hence both gains from trade

d. Before specialization output is given as-

Flotsam-45 Pants and 15 Shirts

Jetsam- 15 Pants and 15 Shirts

Post specialization output Flotsam=60 Pants and Jetsam=60 Shirts suppose Flotsam if keep consumption at 45 pants only it will trade remaing 15 pants for 30 shirt similarly, Jetsam will gain 15 pant and left with (60-30)=30 Shirts Hence Flotsam will gain (30-15)=15 Shirts and Jetsam wil gain (30-15)=15 Pants

e. Gains from trade are possible because the resources are allocated in tbe best possible ways, efficient allocation of resources by countries based upon their comparative advantage lead to increased output and gain from Trade.