Assume that the MRT for Canada is 2 and the MRT for Britain is 0.5 and...

Assume that the MRT for Canada is 2 and the MRT for Britain is 0.5 and both countries only produce wheat (X Good) and cloth (Y Good). Using the concepts of WTP and WTA, discuss both the pattern of trade (who sells and who buys which good) and the potential benefits of trade (economic surplus). Finally, calculate the gains from trade if the negotiated price is 1 wheat for 1 cloth.

Expert Solution

SOLUTION:-

* MRT or marginal rate of transformation is the Marginal cost of Production of X divided by marginal cost of production of Y or MCX/MCY.

* If MRT of canada is 2 it means that is marginal cost of producing X is 2 times the marginal cost of producing Y. So, Canada has low opportunity cost of production of Y and should produce y.

* If MRT of Britain is 0.5 it means that its marginal cost of producing X is 1/2 times the marginal cost of producing Y. So, Britain has low opportunity cost of production of X and should produce X.

* If Canada will produce and sell cloth (Good Y) to Britain and buy wheat (Good X) from Britian then it can produce double the quantity of y as compared to X and hence will be benefitted if it can sell Y for more than 1/2 X.

* If Britain will produce and sell wheat (Good X) to Canada and buy cloth (Good Y) from Canada then it can produce double the quanity of X as compared to Y and hence will be benefitted if it can sell X for more than 1/2 Y.

* If negotiated price is 1 wheat for 1 cloth then gain of trade can be understood using following example:

	Before trade production of Canada	After trade production of Canada	Before trade consumption of canada	After trade consumption of canada	Before trade production of Britain	After trade production of Britain	Before trade consumption of Britain	After trade consumption of Britain
Wheat	5	0	5	5	10	10	5	5
cloth	10	10	0	5	5	0	2	5

* Note: Before trade production is to be taken as only one these can be produced, i.e for Canada either 5 units of wheat can be produced or 10 units of cloth can be produced.

After trade Canada gained 5 units of cloth and Britain gained 3 units of cloth.

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Rahul Sunny answered 2 years ago

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