Assume that France and Britain each produce two goods, champagne and muffins. Th

Question

Assume that France and Britain each produce two goods, champagne and muffins.

The amounts of champagne and muffins that can be produced in a day (if they devote all resources to that good) are shown by the following table:

                                                                   FRANCE                 BRITAIN               

            CHAMPAGNE PER DAY              4,000                          8,000

            MUFFINS PER DAY                      1,000                          4,000

where champagne is measured in litre bottles and muffins are measured in pounds.

            a. Which country is more efficient at producing champagne? Muffins? (Assume

    that each country has the same quantity of resources.)

            b. For France, what is the opportunity cost of champagne? Of muffins?

            c. For Britain, what is the opportunity cost of champagne? Of muffins?

            d. Should France and Britain specialize and trade? (Assume that transportation costs are zero.) Why or why not? If so, in what direction should

                trade take place? Show and explain.

e. What are the terms of trade? Show that their consumption possibilities curves

    lie outside the production possibilities curves. (Hint: What is a trade that both

    would agree to after each specializes?)

Explanation / Answer

a) With the same quantity of resources, Britain is considered to be more efficient in producing champagne. This may because of the efficiency of resources or fuller utilization of resources. Britain is more efficient in producing more champagne per day (8000 litres) as compared to France which produces 4000 litres.

Britain is more efficient in producing muffins too. (the same reason will be applied as above)

b)Opportunity cost of champagne (for France)= 1000/4000= (1/4) which means that to produce 4 litres of champagnes , France have to give up 1 pound of muffin production.

Opportunity cost of muffins (for France) = 4000/1000 = 4 which means that you need to give up 4 litres of champagne to produce 1 pound of muffins.

c) FOR BRITAIN:

Opportunity cost of champagne = 4000/8000= (1/2) which means that Britain has to sacrifice 1 pound of muffin to poduce 2 litres of champagne.

Opportunity cost of muffin= 8000/4000 = 2 which means that Britain need to sacrifice only 2 litre of champagne to produce 1 pound of bread.

d) Yes France and Britain should specialize and trade. France should specialize in the production of champagne because the resources are more efficient in producing champagne. Only 1 pounf of muffin has to sacrificed to produce 4 litres of champagne. Wheres, this is not the case with Britain, since it can produce only 2 litres of champagne by giving up 1 pound of muffin. So, France should trade its extra champagne produced with Britain and Britain should trade its extra muffin produced with France (compare the opportunity cost of producing muffins for both countries like done for champagne.)

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