Question

1. (15 points possible) Brazil and Argentina can both produce beef and sugar. The production possibilities frontiers are given by the table below. (You may assume respectively constant opportunity costs.) Brazil Max. number of per year Beef (000s of tons) Sugar (000s of tons) 15 20 Argentina 30 10 Determine a mutually beneficial trade agreement between Brazil and Argentina; describe it as fully as possible (and draw supporting diagrams). Explain how & why the agreement is beneficial to each party? What are the ranges for acceptable terms-of-trade? . Explain and illustrate with appropriate diagrams. Explain your reasoning as thoroughly as possible using appropriate Econ 40 concepts & tools.

Answer 1

1. Brazil can produce 15,000 tons of beef or 20,000 tons of sugar.

Relative price in Brazil is = 15,000 tons of beef per 20,000 tons of sugarbeef = 0.75 tons of beef per ton of sugar.

Opportunity cost of producing beef in Brazil = tons of sugar sacrificed / tons of beef produced = 20,000/15,000 = 1.33

Opportunity cost of producing sugar in Brazil = tons of beef sacrificed / tons of sugar produced = 15,000/20,000 = 0.75

Argentina can produce 30,000 tons of beef or 10,000 tons of sugar.

Relative price in Argentina is = 30,000 tons of beef per 10,000 tons of sugar = 3 tons of beef per ton of sugar.

Opportunity cost of producing beef in Argentina = tons of sugar sacrificed / tons of beef produced = 10,000/30,000 = 0.33

Opportunity cost of producing sugar in Argentina = tons of beef sacrificed / tons of sugar produced = 30,000/10,000 = 3

As opportunity cost of producing sugar is lower for Brazil, Brazil has comparative advantage in the production of sugar.

Again, as opportunity cost of producing beef is lower for Argentina, Argentina has comparative advantage in the production of sugar.

Let , initially, Brazil was producing and consuming 7,500 tons of beef and 10,000 tons of sugar, whereas, Argentina was producing 15,000 tons of beef and 5,000 tons of sugar.

For trade, Brazil must produce sugar only (i.e., 20,000 tons) and Argentina must produce beef only (i.e., 30,000 tons), according to their comparative advantage in each good.

Terms of trade must lie in the range of their relative prices i.e., 0.75 tons of beef per ton of sugar < TOT < 3 tons of beef per ton of sugar.

Suppose, TOT is 1.5 tons of beef per ton of sugar, then, if Brazil consumes 10,000 tons of sugar (out of 20,000 tons of sugar production), it can export remaining 10,000 tons of sugar to Argentina. In return, Brazil gets 1.5*10,000 = 15,000 tons of beef. Thus, Brazil gains 15,000-7,500 = 7,500 tons of beef from trade.

Similarly, when TOT is 1.5 tons of beef per ton of sugar, then, if Argentina consumes 15,000 tons of beef (out of 30,000 tons of beef production), it can export remaining 15,000 tons of beef to Brazil. In return, Argentina gets 15,000/1.5 = 10,000 tons of sugar. Thus, Argentina gains 10,000-5,000 = 5,000 tons of sugar from trade.

We have shown the initial consumption points (without trade) as A and final consumption points (with trade) as B on the PPF for Brazil and Argentina below:

Beef Beef 30,000 PPF for Argentina 15,000 B A B 15,000 10,000 7,500 PPF for Brazil 10,000 20,000 Sugar 5,000 10,000 Sugar