Question

Consider the following theoretical sample of countries who can produce the following goods using only labor. Each unit of labor can produce the following amount of output:

                                                    Cars              Shoes

                        China                     10                   500

                        India                      2                     400

                        Brazil                     5                     250

1. If the price of a shoe is $1, what is the relative price of a car in each country in autarky (i.e. when there is no trade)?

2. Consider each of the 3 possible trading pairs in turn: China-India, China-Brazil, India-Brazil. Assuming free and frictionless trade and that each of these pairs could only trade with one another at a time, who would want to trade what and why?

Answer 1

1) China can produce either 10 cars or 500 shoes. If price of shoes is $1, worth of 500 shoes would be $500. Thus price of one car 500 / 10 = $50

India can produce either 2 cars or 400 shoes. If price of shoes is $1, worth of 400 shoes would be $400. Thus price of one car 400 / 2 = $200

Brazil can produce either 5 cars or 250 shoes. If price of shoes is $1, worth of 250 shoes would be $250. Thus price of one car 250 / 5 = $50

2)

	Cars	Shoes	Opportunity Cost of 1 car with respect to shoes	Opportunity cost of 1 shoes with respect to car
China	10	500	50	0.02
India	2	400	200	0.005
Brazil	5	250	50	0.02

In trade between China - India, India owns comparative advantage in producing shoes because of lower opportunity cost while China owns comparative advantage in producing car because of lower opportunity cost. China will imports shoes from India and exports cars.

In trade between China - Brazil, both countries have the same opportunity cost of both products. No country will gain from trade.

In trade between India - Brazil, India owns comparative advantage in producing shoes because of lower opportunity cost while Brazil owns comparative advantage in producing car because of lower opportunity cost. Brazil will imports shoes from India and exports cars.