Question

Output per Hour Worked
	France	Germany
Cheese	4 kilogram	8 kilograms
Cars	1/2	8

a.Which country has an absolute advantage in cheese? In cars?  

b.What is opportunity cost of cheese in France? In Germany?

c. Which country has a comparative advantage in cheese? In cars?

d.What are the upper and lower bounds for the trade price of cheese? Use correct notation.

e.(i)Draw a LARGE graph of a hypothetical PPC for France and label its slope, and other relevant points.

(iii) Suppose that France follows its comparative advantage in deciding where to produce on its PPC, label its production point with trade.

(iii) If we assume the nations trade at 1 car for 4 cheese, draw a trade line, make sure to use the information provided to label your graph fully

(iv) using the same graph show how France can gain from trade.

(v) Give a simple example.

Answer 1

(a)

Germany can make more cheese per hour than France can (8 > 4), so Germany has absolute advantage in cheese.

Germany can make more car per hour than France can (8 > 1/2), so Germany has absolute advantage in car.

(b)

Opportunity cost of cheese in France = (1/2) / 4 = 1/8 = 0.125 cars

Opportunity cost of cheese in Germany = 8/8 = 1 car

(c)

Since France can make cheese at lower opportunity cost than Germany can (0.125 < 1), France has comparative advantage in cheese.

Accordingly, Germany has comparative advantage in cars.

(d)

Trade is mutually beneficial if terms of trade (TOT) lies between the opportunity cost in both countries. So

0.125 cars < TOT of cheese < 1 car, or equivalently:

1 cheese < TOT of car < (1/0.125) cheese, i.e.

1 cheese < TOT of car < 8 cheese.

NOTE: As per Answering Policy, 1st 4 parts are answered.