Question

Question 3

Suppose that two economies (Vietland and Japanesia) each produce only two goods (Car and Soap). Vietland requires 1,000 work hours to produce a car, whereas Japanesia requires only 800 work hours to do the same. Japanesia can produce 0.01 ton of soap per hour, whereas Vietland can produce 0.05 ton of soap per hour. Each country has 1,000,000 work hours available per day. Initially, in the absence of trade, each nation chose to efficiently produce (and consume) 500 cars per day. Now, both nations agree to freely trade with each other at an exchange rate of 1 car for 10 tons of soap. Suppose that each nation fully specialises in the good in which it has comparative advantage. If each nation still chooses to consume 500 cars per day, what is each nation’s gains from trade in terms of soap? Explain in detail, and illustrate your answer in a diagram.

Answer 1

One unit output in hours

	Cars	Soap(1 ton)
Vietland	1,000 hours	20 hours
Japanesia	800 hours	100 hours

Both countries have 1,000,000 work hours thus we can determine the output of cars and soaps

	Cars	Soaps
Vietland	1,000	50,000
Japanesia	1,250	10,000

Now, we can calculate the opportunity cost as follows

Opportunity Cost

	1 unit of Car	1 ton of soap
Vietland	50 tons of soap	0.02 units of car
Japanesia	8 tons of soap	0.125 units of car

The opportunity cost producing car is less in Japanese and in case of soap it is low in Vietland. Thus, Japanesia has comparative advantage in producing cars and Vietland has comparative advantage in producing soaps.

	Vietland		Japanesia
	Cars	Soaps	Cars	Soaps
Production	500	25,000	500	5,000
Consumption	500	25,000	500	5,000
After specialization
Production	0	50,000	1,250	0
Trade effect	500	- 5,000	- 500	5,000
Consumption	500	45,000	750	5000
Gain from trade	0	20,000	250	0

Gains from trade I have calculated in the above table.

Refer the attached picture for graphical representation

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