Question

This problem illustrates an example of trade induced by comparative advantage. It assumes that China and France each have 1,000 production units. With one unit of production​ (a mix of​ land, labor,​ capital, and​ technology), China can produce either 12 containers of toys or 7 cases of wine. France can produce either 2 cases of toys or 7 cases of wine.​ Thus, a production unit in China is five times as efficient compared to France when producing​ toys, but equally efficient when producing wine. Assume at first that no trade takes place. China allocates 750 production units to building toys and 250 production units to producing wine. France allocates 250 production units to building toys and 750 production units to producing wine.

a. What is the production and consumption of China and France without​ trade?

b. Assume complete​ specialization, where China produces only toys and France produces only wine. What would be the effect on total​ production?

c.​ France's domestic price is 2 containers of toys equals 7 cases of wine. Assume China produces 12,000 containers of toys and exports 500 containers to France. Assume France in turn produces 7,000 cases of wine and exports 1,750 cases to China. What happens to total production and​ consumption?

Answer 1

What is the production and consumption of China and France without trade?

Toys Wine
Assumptions (containers/unit) (cases/unit)
China -- output per unit of production input * 10 * 7
France -- output per unit of production input * 2 * 7
China -- total production inputs * 1,000
France -- total production inputs * 1,000

Production if there is no trade Toys Wine

CHINA
Allocated production units to * 800 * 200
Produces and consumes (output per unit x units allocated) * 8,000 * 1,400

FRANCE
Allocated production units to * 200 * 800
Produces and consumes (output per unit x units allocated) * 400 * 5,600

Total production and consumption across both countries * 8,400 * 7,000

Assume complete specialization, where China produces only toys and France produces only wine. What would be the effect on total production?

Toys Wine
Assumptions (containers/unit) (cases/unit)
China -- output per unit of production input * 10 * 7
France -- output per unit of production input * 2 * 7
China -- total production inputs * 1,000
France -- total production inputs * 1,000

Production if there is complete specialization Toys Wine

CHINA
Allocated production units to * 1,000 0.0
Produces and consumes (output per unit x units allocated) * 10,000 0.0

FRANCE
Allocated production units to 0.0 * 1,000
Produces and consumes (output per unit x units allocated) 0.0 * 7,000

Total production and consumption across both countries * 10,000 * 7,000

The combined production of both countries is 10,000 containers of toys, 1,600 more containers of toys than
before specialization, with wine production remaining unchanged.

China\u2019s domestic price is 10 containers of toys equals 7 cases of wine. Assume China produces 10,000 containers of toys and exports 2,000 containers to France. Assume France produces 7,000 cases of wine and exports 1,400 cases to China. What happens to total production and consumption?

Toys Wine
Assumptions (containers/unit) (cases/unit)
China -- output per unit of production input * 10 * 7
France -- output per unit of production input * 2 * 7
China -- total production inputs * 1,000
France -- total production inputs * 1,000

TOYS WINE
Toy Exports (-)/ Domestic Wine Exports (-)/ Domestic
Trade at China's domestic price (10 toys = 7 wine) Production Imports (+) Consumption Production Imports (+) Consumption

CHINA
Allocated production units to * 1,000 0.0
Produces and consumes (output per unit x units allocated) * 10,000 * (2,000) * 8,000 0.0 * 1,400 * 1,400

FRANCE
Allocated production units to 0.0 * 1,000
Produces and consumes (output per unit x units allocated) 0.0 * 2,000 * 2,000 * 7,000 * (1,400) * 5,600

Total production and consumption across both countries * 10,000 * 10,000 * 7,000 * 7,000

With complete specialization, toy production in total is increased as in Problem 2.
Toy production and consumption in France increases from 400 containers of toys before trade to 2,000 containers after trade, a gain in consumption of 1,600 containers.
Wine production and consumption remains the same as before trade. China is now consuming 8,000 containers of toys and 1,400 cases of wine, the same levels of both as prior to trade. Hence all of the benefits of trade have gone to France.

France\u2019s domestic price is 2 containers of toys equals 7 cases of wine. Assume China produces 10,000 containers of toys and exports 400 containers to France. Assume France in turn produces 7,000 cases of wine and exports 1,400 cases to China. What happens to total production and consumption?

Toys Wine
Assumptions (containers/unit) (cases/unit)
China -- output per unit of production input * 10 * 7
France -- output per unit of production input * 2 * 7
China -- total production inputs * 1,000
France -- total production inputs * 1,000

TOYS WINE
Toy Exports (-)/ Domestic Wine Exports (-)/ Domestic
Trade at France's domestic price (2 toys = 7 wine) Production Imports (+) Consumption Production Imports (+) Consumption

CHINA
Allocated production units to * 1,000 0.0
Produces and consumes (output per unit x units allocated) * 10,000 * (400) * 9,600 0.0 * 1,400 * 1,400

FRANCE
Allocated production units to 0.0 * 1,000
Produces and consumes (output per unit x units allocated) 0.0 * 400 * 400 * 7,000 * (1,400) * 5,600

Total production and consumption across both countries * 10,000 * 10,000 * 7,000 * 7,000

Toy production and consumption in China increases from 8,000 containers of toys before trade to 9,600 containers -- 1,600 more containers -- after trade. Wine production and consumption remains the same as before trade. Thus the full benefit of trade goes to China when trading at France's domestic prices.

The mid-price for exchange between France and China can be calculated as follows:

Toys Wine
Assumptions (containers/unit) (cases/unit)
China -- output per unit of production input * 10 * 7
France -- output per unit of production input * 2 * 7
China -- total production inputs * 1,000
France -- total production inputs * 1,000

What happens to total production and consumption?

TOYS WINE
Toy Exports (-)/ Domestic Wine Exports (-)/ Domestic
Trade at Negotiated Mid-Price (6 toys = 7 wine) Production Imports (+) Consumption Production Imports (+) Consumption
CHINA
Allocated production units to * 1,000 0.0
Produces and consumes (output per unit x units allocated) * 10,000 * (1,200) * 8,800 0.0 * 1,400 * 1,400

FRANCE
Allocated production units to 0.0 * 1,000
Produces and consumes (output per unit x units allocated) 0.0 * 1,200 * 1,200 * 7,000 * (1,400) * 5,600

Total production and consumption across both countries * 10,000 * 10,000 * 7,000 * 7,000

China gains 800 more containers of toys (8,800 post-trade compared to 8,000 pre-trade), and enjoys the same level of wine consumption (1,400).
France gains 800 more containers of toys (1,200 post-trade compared to 400 pre-trade), and enjoys the same level of wine consumption (5,600).
Wine production therefore remains the same as before trade, but now the 1,600 increased production of toys is split evenly between the two countries.