Question

England siues up Bread for checse 4 0.05 Cheese for Breal 8-5-2 Span Siues up Uniti Problem 4 Nomber ef ts Predeced le 40 1rs Lahor Hasrs Needed to Make 1Uof Bread Choe Cheese Broad Englnd Sp Figure 3: Assume that England and Spain can switch between producing cheese and pro- ducing bread at a constant rate Part A Identify which country has an absolute advantage and which country has a comparative Bread Spa Comp Enl Ab solu Cheese advantage in cheese making? bread making Part B Without trade, England produced and consumed 32 units of cheese and 2 units of bread and Spain produced and consumed 6 units of cheese and 2 units of bread Then, each country agreed to specialize in the production of the good in which it has a comparative advantage and trade 7 units of cheese for 2.5 units of bread As a result, England gained how much Und cheese bread and how much cheese? , 1Bread 5 Un Part C At which of the following prices would both counties gain from trade with each other? a 16 units of bread for 16 units of cheese b 16 mits of bread for 48 units of cheese 1:3raho hishestaho e 16 units of bread for 24 units of cheese 11S caho d England and Spain could not both gain from trade with each other at any price 7 e 2.5u 10-

Answer 1

(PART A)

(a)

Since England can make more cheese than Spain can (40 > 10) and also can make more bread than Spain can (10 > 5), England has absolute advantage in both cheese and bread.

(b)

Opportunity cost (OC) are computed as follows.

In England,

OC of cheese = 10/40 = 0.25 bread

OC of bread = 40/10 = 4 cheese

In Spain,

OC of cheese = 5/10 = 0.5 bread

OC of bread = 10/5 = 2 cheese

Since England can make cheese at a lower OC than Spain can (0.25 < 0.50), England has comparative advantage in and should specialize in cheese. Accordingly, Spain has comparative advantage in and should specialize in bread.

(PART B)

With specialization, England makes 40 cheese and Spain makes 5 bread.

England exports 7 cheese and imports 2.5 bread. Spain exports 2.5 bread and imports 7 cheese.

In England,

Consumption of cheese after trade = 40 - 7 = 33

Increase in consumption of cheese after trade = 33 - 32 = 1

Consumption of bread after trade = 2.5

Increase in consumption of bread after trade = 2.5 - 2 = 0.5

(PART C) Option (b)

Trade is mutually beneficial when Terms of Trade (TOT) lies between the OC in both countries. Acceptable TOT is:

0.25 bread < TOT of cheese < 0.5 bread

TOT for option (a) = 16/16 = 1 bread (not acceptable)

TOT for option (b) = 16/48 = 0.33 bread (acceptable)

TOT for option (c) = 16/24 = 0.67 bread (not acceptable)