Question

The Table below shows the production capacity per unit of input for two countries. E.g. if Country B spends 1 input on magnets, it will produce 50 magnets.

	country B	country C
magnets	50	5
pies	20	10

  

        

(5A) Imagine that both countries are initially not trading and have 10 inputs each. They split their inputs evenly in the production of both goods. Describe what the total gains from trade potentially are if the countries change their production patterns and begin trading. Ensure you describe a situation where there has been an unambiguous gain from trade.

(5B) Describe the maximum and minimum price that magnets will be traded for (price described in terms of pies).

(5C) Describe the maximum and minimum price that pies will be traded for (price described in terms of magnets).

Answer 1

Country B can produce 50 magnets or 20 pies in one unit of input.
The country C

can produce 10 magnets and 20 pies and each country has 10 units of input which are split evenly.

5A) We will first calculate the total output when there is no trade

	Country B	Country C	Total
Magnets	50 * 5 = 250	5 * 5 = 25	275
Pies	20 * 5 = 100	10 * 5 = 50	150

Country B has an absolute advantage in both the products.
The absolute advantage refers to the situation where a country or economic agents can produce with lower resources compared to its competitors.

However, country B will be better off by producing only magnets since its has a comparative advantage in that.
A comparative advantage is the scenario where a country or an economic agents can produce goods at lower opportunity cost.

Country B
1 magnet = 0.4 pie
1 pie = 2.5 magnet

Country C
1 magnet = 2 pie
1 pie = 0.5 magnet

Country B has a comparative advantage in magnets and country C has a comparative advantage in pies.
They will specialize in that and then can trade surplus.

	Country B	Country C	Pre Trade Total	Post Trade Total	Gains
Magnets	50*10 = 500	0	275	500	+225
Pies	0	10*10=100	150	100	-50

5B) The price of the magnets which will traded will lie between the band of opportunity cost of both the countries for a magnet.

Country B
1 magnet = 0.4 pie

Country C
1 magnet = 2 pie

The price of a magnet will lie in between 0.4 pie and 2 pie.

5C) In the same manner, the price of the pie will lie in between the band of the opportunity cost of the pie of both countries.

Country B
1 pie = 2.5 magnet

Country C
1 pie = 0.5 magnet

The price will lie in between 0.5 magnet and 2.5 magnet.