Consider the following constant opportunity cost annual production possibilities

Question

Consider the following constant opportunity cost annual production possibilities for China and Spain.

                            China                                               Spain

Sushi (tons)     Chips (tons)      Sushi (tons)     Chips (tons)

100                  0                      30                    0

80                    5                      24                    2

60                    10                    18                    4

40                    15                    12                    6

20                    20                    6                      8

0                      25                    0                      10

a. If China and Spain specialize in the good for which they have a comparative advantage, what would be the rage of trade possibilities? Carefully explain.

b. If 2/7 C exchanges for 1S, what are the gains from trade, if any, for China and Spain? Support your response.

Explanation / Answer

If we look at the table, we see that there is a constant opportunity cost of 1 tons of chips in China and it is 20/5 = 4 tons of Sushi. In Spain, the same opportunity cost is 6/2 = 3 tons. Given this, we conclude that China has a higher opportunity cost of chips and so China should specialize in Sushi and Spain should specialize in chips.

a. If China and Spain specialize in the good for which they have a comparative advantage, China produces 100 tons Sushi and no chips while Spain will produce no Sushi and 10 tons of chips. Hence the trade price of 1 one ton of chips will lie between the two opportunity costs and this range is 3 tons to 4 tons of Sushi.

Similarly the trade price of 1 ton of sushi lies between 1/4 to 1/3 tons of chips.

b. When the price of 1 ton of sushi is 2/7 tons of chips, China can export 21 tons of Sushi and in exchange it imports 21 x 2/7 = 6 tons of chips. This makes its consumption bundle of 79 tons of Sushi and 6 tons chips. China clearly wins from trade because before trade, when it was producing and consuming 6 tons of chips, it was able to produce and consume only (100 - 6*4) = 76 tons of sushi so it is now better off

Similarly, Spain now has 21 tons sushi and 4 tons of chips. Spain also wins from trade because before trade, when it was producing and consuming 4 tons of chips, it was able to produce and consume only 18 tons of sushi so it is now better off

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