Germany and France produce guns and butter. Germany: 10 units labor per gun, 5 u

Question

Germany and France produce guns and butter.

Germany: 10 units labor per gun, 5 units labor per lb butter.

France: 15 units labor per gun, 10 units labor per lb butter.

a. Who has the comparative advantage in which good? You must show your work to get credit, e.g. by calculating the relative opportunity costs of guns in each economy.

b. What if the cost of labor in France is 1 Franc and in Germany is 1 Mark, and the exchange rate is 1 Mark for 1 Franc? Will two way trade take place? Explain.

c. What is the range of exchange rates at which two way trade can take place?

Explanation / Answer

A.         The cost of all goods is lower in Germany than in France in the sense that all goods can be produced with fewer worker hours.

B. The cost of any good for which France has a comparative advantage is lower in France than in Germany. Though Germany produces all goods with less labor, that labor may be more valuable in the production of some goods and services. So the cost of production, in terms of opportunity cost, will be lower in France for some goods.

.C. Trade between Germany and France will benefit both countries. For each good in which it has a comparative advantage, each country should produce more goods than it consumes, trading the rest to the other country. Total consumption will be higher in both countries as a result.

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