Question

Q.4 (18 points) Suppose that Germany and France both produce cheese and wine. The amount of production of the two countries are shown in the following table. Assume that the opportunity cost is constant. Germany France Daily production Produce cheese only (pounds) Produce wine only (bottles) 300 150 150 100 (a) Draw the PPF for Germany. Put cheese on the vertical axis, and wine on the horizontal axis. Indicate the values of both intercepts. (b) Which country has the absolute advantage in producing cheese? (c) Complete the following table (don't forget the units) Opportunity cost of producing 1 pound of cheese 1 bottle of wine Germany France (d) Which country has the comparative advantage in producing wine? (e) For each of the following prices, determine if France will be willing to trade. Also, determine if Germany will be willing to trade. The price of 1 bottle of wine is 3 pounds of cheese. (ii) The price of 1 bottle of wine is 1 pound of cheese. (iii) The price of 1 bottle of wine is 1.8 pound of cheese. (1) Now France improves cheese production technology, it can now produce a maximum of 180 pounds of cheese per day. The new amount of production is shown in the following table. Daily production Produce cheese only (pounds) Produce wine only (bottles) 300 150 180 100 Germany France Find the new range of price of a bottle of wine such that both Germany and France will be willing to trade. Then explain why Germany benefits less when France has better cheese production technology.

just need e and f

Answer 1

Question 4

e.)

From the table, we can see that -

• Germany produces 300 pounds of cheese and 150 bottles of wine. Hence, if it were to produce only cheese, it would have to give up 150 bottles of wine. This means germany gives up 1 bottle of wine for every 2 pounds of cheese. Opportunity cost of producing one pound cheese for Germany is 0.5 bottles of wine. Hence, it will be willing to trade only if it can get more than 1 bottle of wine for 2 pounds of cheese.
• France produces 150 pounds of cheese and 100 bottles of wine. Hence, if it were to produce only wine, it would have to give up 150 pounds of cheese. This means France gives up 1.5 pounds of cheese for every 1 bottle of wine. Opportunity cost of producing 1 bottle of wine for France is 1.5 pounds of cheese. Hence, it will be willing to trade only if it can get more than 1.5 pounds of cheese for every bottle of wine.

The three options for us are -

1. 1 bottle of wine / 3 pounds of cheese
2. 1 bottle of wine / 1 pound of cheese
3. 1 bottle of wine / 1.8 pounds of cheese

France will give 1 bottle of wine for anything more than 1.5 pounds of cheese, which means options 1 and 3 are both acceptable for France. Germany will be willing to trade only if it can get more than 1 bottle of wine for 2 pounds of cheese, or conversely, if it can give less than 2 pounds of cheese for 1 bottle of wine. Which means options 2 and 3 are acceptable for Germany. Hence, the mutually agreed upon price will be option 3 - 1 bottle of wine for 1.8 pounds of cheese.

f.)

From the table, we can now see that -

• Germany produces 300 pounds of cheese and 150 bottles of wine. Hence, if it were to produce only cheese, it would have to give up 150 bottles of wine. This means germany gives up 1 bottle of wine for every 2 pounds of cheese. Opportunity cost of producing one pound cheese for Germany is 0.5 bottles of wine. Hence, it will be willing to trade only if it can get more than 1 bottle of wine for 2 pounds of cheese.
• France produces 180 pounds of cheese and 100 bottles of wine. Hence, if it were to produce only wine, it would have to give up 180 pounds of cheese. This means France gives up 1.8 pounds of cheese for every 1 bottle of wine. Opportunity cost of producing 1 bottle of wine for France is 1.8 pounds of cheese. Hence, it will be willing to trade only if it can get more than 1.8 pounds of cheese for every bottle of wine.

Hence, the only acceptable terms of trade will be if the two countries trade at the point where the prices are established as 1 bottle of wine for 1.9 pounds of cheese.

In this case, since Germany benefits less from this trade. If Germany produces 300 pounds of cheese and hypothetically exchanges all of it for wine, it will get 158 bottles of wine (300 / 1.9), it can produce 150 bottles at home, hence it gains 8 bottles of wine. On the other hand, if France produces 100 bottles of wine and hypothetically exchanges all of it for cheese, then it gets 190 pounds of cheese (1.9 x 100), it can produce 180 pounds at home, hence it gains 10 pounds of cheese, which is more than what Germany gains.