Question

Consider a scenario in which each person is an island. In this scenario, James and Kate engage in international trade with each other.

James is lactose intolerant and only produces cheese. Kate is caffeine intolerant and only produces coffee. Thus, both "countries" export all their production to the other. This month James produced 2525 pounds of cheese and Kate 1515 pounds of coffee. For simplicity, assume that they share a common currency (the US dollar) and that the price of a pound of coffee is $1, the same as a pound of cheese.

Who has a negative trade balance with the other country?

Kate

Both

Neither

James

What is the direction of the flow of international savings?

Kate is sending a flow of $10.00 as a loan to James.

Kate is receiving a flow of James' savings that amounts to $10.00.

James is receiving a flow of Kate's savings that amounts to $10.00.

Neither of them is borrowing or saving, as this was only a merchandise transaction

Answer 1

Solution:

1. Trade balance = value of exports - value of imports

As each of the islands (or persons) exports the entire of its production and imports entire of other's production, and this trade is carried out at exchange of price of pound of coffee = price of pound of cheese = $1.

So, as James produce and export 2525 pounds of cheese and imports 1515 pound of coffee, for James, trade balance = 1*2525 - 1*1515 = $1010

Trade balance for Kate = 1*1515 - 1*2525 = -$1010

So, Kate has a negative trade balanve, correct option is (A) Kate.

2. As no borrowing or saving is in the picture, the correct option is (D).