Answer to Question #212099 in Microeconomics for help

Question

Suppose Germany and France each produce only two goods, guns and butter. Both are produced using labor alone. Assuming both countries are at full employment, you are given the following information: Germany: 10 units of labor required to produce 1 gun 5 units of labor required to produce 1 pound of butter Total labor force: 1,000,000 units France: 15 units of labor required to produce 1 gun 10 units of labor required to produce 1 pound of butter Total labor force: 750,000 units . a) if transportation cost are ignored and trade is allowed, will france and germany engage in trade? explainb) if a trade agreement were negotiated, at what rate number of guns per unit of butter would they agree to exchange.

Answer 1

a.

Both France and Germany would engage in trade if trade is allowed and transportation costs ignored.

Wit the labor given, both countries can produce the following quantities if the resources are utilized in production of any one good.

If the two countries using their resources produces a good in which they have comparative advantage, France would engage all its resources in gun production while Germany would produce Butter using all its resources.

Therefore, in absence of transportation costs both countries would export the commodity in which it has comparative advantage and import the commodity in which it has a comparative disadvantage.

b.

If France and Germany decide to trade with each other, the trade agreement will be based on the comparative advantage theory.

The opportunity cost table for the two countries is as shown below.

The opportunity cost of gun production is low in France therefore France will specialize in gun production. However, Germany will specialize in Butter production because the opportunity cost of producing one pound of Butter is low in Germany.

The agreement is based on trade terms in consideration of the ratio on which a nation can trade imported goods with domestic goods.

$0.5\le TOT\le0.66$

Where TOT is the terms of trade somewhere between the opportunity cos of good production.

Therefore, France and Germany would agree to exchange at a price ratio with more than 0.5 and less than 0.66