Question

Use the production possibilities tables to answer the following questions.

Germany’s Production Possibilities
	A	B	C	D	E	F
Autos (millions)	0	4	8	12	16	20
Chemicals (millions)	40	32	24	16	8	0
United States’ Production Possibilities
	A	B	C	D	E	F
Autos (millions)	0	3	6	9	12	15
Chemicals (millions)	60	48	36	24	12	0

1. If Germany and the United States engage in trade, the mutually beneficial terms of trade will be between _____ and _____ units of chemicals for _____ unit of autos.
2. Assume that prior to specialization and trade Germany and the United States both produced combination C. Now if each nation specializes, according to its comparative advantage, what will be the resulting gains from specialization and trade? ____________
3. Suppose that each nation specializes in producing the product for which it has a comparative advantage, and the terms of trade are set at 3 units of chemicals for 1 unit of autos. In this case, Germany could obtain and consume a maximum combination of _________ units of autos and __________ units of chemicals.

Answer 1

a. If Germany and the United States engage in trade, the mutually beneficial terms of trade will be between __2___ and __4___ units of chemicals for ___1__ unit of autos.

Opportunity cost of 1 auto in Germany = Total Chemicals given up/Total autos produces = 40/20 = 2 chemicals
Opportunity cost of 1 auto in Us = Total Chemicals given up/Total autos produces = 60/15 = 4 chemicals
So, terms of trade will be between 2 and 4 units of chemicals.

b. Assume that prior to specialization and trade Germany and the United States both produced combination C. Now if each nation specializes, according to its comparative advantage, what will be the resulting gains from specialization and trade? _____6 million autos and zero chemicals_______

Germany will specialize in Autos as its opportunity cost is lower in it. So, US will specialize in chemicals.
Before trade (At C), total autos produced = 8 + 6 = 14 million and chemical produced = 24 + 36 = 60 million
After trade, total autos = 20 million (produced only by Germany) and chemicals = 60 million (produced only by US)
So, gain in autos = 20 - 14 = 6 million and gain in chemicals = 60 - 60 = 0

c. Suppose that each nation specializes in producing the product for which it has a comparative advantage, and the terms of trade are set at 3 units of chemicals for 1 unit of autos. In this case, Germany could obtain and consume a maximum combination of ____8 million_____ units of autos and ___36 million_______ units of chemicals.

Germany can still consume 8 million autos and trade remaining autos with US for chemicals.
Remaining autos = 20 - 8 = 12 autos
1 auto = 3 units of chemicals
So, 12 autos = 12*3 = 36 million chemicals