Answer the next three questions on the basis of the following production possibilities data for Francia and Galacia. All data are in tons. (3 marks)
Francia production possibilities:
A B C D E
Soup 60 45 30 15 0
Nuts 0 15 30 45 60
Galacia production possibilities:
A B C D E
Soup 20 15 10 5 0
Nuts 0 15 30 45 60
(a) If trade occurs between Francia and Galacia, which nation should export what product? Why?
(b) What are the limits of the terms of trade between Francia and Galacia?
(c) Assume that prior to specialization and trade, Francia and Galacia chose production possibility “C.� Now each specializes according to comparative advantage. What will be the resulting gains from trade? Explain your answer.
If trade occurs between Francia and Galacia, which nation should export what product? Why?
galacia will produce and export soup and fancia produce and export galacia
(a) If trade occurs between Francia and Galacia, Francia should export Nuts and Galacia should export Soup.
This is because Francia has a comparative advantage in producing Nuts as it can produce more Nuts than Galacia at every level of Soup production. Similarly, Galacia has a comparative advantage in producing Soup as it can produce more Soup than Francia at every level of Nuts production. By specializing in their comparative advantage products and trading with each other, both countries can benefit from increased efficiency and higher overall production.
(b) The limits of the terms of trade between Francia and Galacia depend on their respective opportunity costs. The terms of trade will be determined by the ratio at which both countries are willing to exchange their products.
For example, if Francia values Nuts more than Soup, and Galacia values Soup more than Nuts, they may agree to trade at a ratio of 2 Nuts for 1 Soup. However, the actual limits will depend on the negotiating power and willingness of both countries to exchange their products.
(c) Assuming that prior to specialization and trade both Francia and Galacia chose production possibility "C," the resulting gains from trade will be an increase in overall production and consumption for both countries.
By specializing in their comparative advantage products and trading, Francia can now produce more Nuts and Galacia can produce more Soup. This specialization allows both countries to allocate their resources more efficiently and produce beyond their previous production possibilities. As a result, there will be an increase in the total output of both Nuts and Soup, leading to higher levels of consumption and economic welfare for both Francia and Galacia.
(a) To determine which nation should export what product, we need to compare the opportunity costs of producing each product in Francia and Galacia. The opportunity cost is the value of the next best alternative that is given up when making a decision.
In Francia, the opportunity cost of producing 1 ton of Soup is determined by comparing the amount of Nuts that could be produced instead. For example, in Francia, producing 1 ton of Soup requires giving up the production of 3 tons of Nuts (moving from point C to point D on the production possibilities curve).
In Galacia, the opportunity cost of producing 1 ton of Soup is determined in the same way. Producing 1 ton of Soup in Galacia requires giving up the production of 2 tons of Nuts (moving from point C to point D on the production possibilities curve).
Comparing the opportunity costs, we see that Francia has a higher opportunity cost of producing Soup (3 tons of Nuts) compared to Galacia (2 tons of Nuts). Therefore, Francia has a comparative advantage in producing Nuts, and Galacia has a comparative advantage in producing Soup.
Based on this, Francia should export Nuts and Galacia should export Soup.
(b) The limits of the terms of trade between Francia and Galacia depend on the opportunity costs of each nation and the agreed upon terms of trade. The terms of trade refer to the rate at which two nations exchange goods.
For example, if Francia and Galacia agree to exchange 1 ton of Soup for 3 tons of Nuts, the terms of trade would be 1:3. This means that Francia is willing to trade 1 ton of Soup for 3 tons of Nuts.
The limits of the terms of trade will be influenced by the opportunity costs and preferences of each nation. For example, if Francia's opportunity cost of Soup decreases (i.e., it becomes more efficient at producing Soup), it may demand a better exchange rate or a higher ratio of Nuts to Soup in the terms of trade.
It is important to note that the limits of the terms of trade will be determined through negotiations and agreements between the two nations.
(c) Assuming that Francia and Galacia specialize according to their comparative advantage, Francia will specialize in producing Nuts, and Galacia will specialize in producing Soup.
By specializing, both nations can allocate their resources more efficiently and produce more output. Francia, by focusing on Nuts, can produce 60 tons of Nuts (moving from point C to point E on its production possibilities curve). Galacia, by focusing on Soup, can produce 20 tons of Soup (moving from point C to point A on its production possibilities curve).
After specialization and trade, Francia can export Nuts to Galacia, while Galacia can export Soup to Francia. Both nations can then benefit from trade by consuming a combination of goods that lies beyond their individual production possibilities curves.
The resulting gains from trade include increased total output, greater variety of goods, and the ability to consume goods that were previously unavailable due to production constraints.
Overall, specialization and trade allow both nations to produce more efficiently and achieve higher levels of economic welfare.