Week 1
What is the effect of moving from autarky to free trade on consumer surplus and producer
surplus? What is the net national gain/loss?
Qd = 175 - P / 2
Qs = -100 + 5P
Price autarky = 50
World price (free trade) = 30
Gain consumer surplus: A + B1 + B2 + C
Producer surplus loss: A + B1
→ (50 - 30) x 50 = 1000 (A), 0,5 x (50 - 30) x (150
- 50) = 1000 (B1), 1000 + 1000 = 2000
Net (welfare) gain: B2 + C
→ 0,5 x (160 - 50) x (50 - 30) = 1100
,Week 2
1. There are two products, cars and wine, and two producers, France and Japan. Assume that it
takes France 16 hours to produce one car and 5 hours to produce one unit of wine. In Japan, it
takes 18 hours to produce one car and 9 hours to produce one unit of wine.
Wine Cars
France 5 hrs 16 hrs
Japan 9 hrs 18 hrs
a) Calculate the relative price of cars in France and Japan under autarky.
No money in autarky, so good 1 in terms of good 2. Relative price of cars = Pc/Pw →
#W/C
France: Pc/Pw = (16 hrs/car)/(5 hrs/wine) = 3,2 W/C
Japan: Pc/Pw = (18 hrs/car)/(9 hrs/wine) = 2 W/C
b) Which country has an absolute advantage in the production of cars, which country has an
absolute advantage in the production of wine? Which country has a comparative advantage in
the production of cars, which country has a comparative advantage in the production of wine?
France has an absolute advantage in producing wine and cars, Japan has a comparative
advantage in producing cars and France has a comparative advantage in producing wine.
c) When France and Japan open up to free trade, is it possible that the free-trade equilibrium
world price is 1.5W/C? Explain. If this is not an equilibrium price, should the price be higher or
lower than this level and which forces will bring about the required change in the price?
World price must be in between autarky prices (France: 3,2 W/C - Japan: 2 W/C).
● 1,5 W/C < 2 W/C: France wants to import cars, but Japan is not willing to sell.
● Excess demand for cars drives up the relative world price of cars until it falls in the range
(2 W/C, 3,2 W/C).
2. Take the labor hours needed to produce wine and cars in France and Japan from question 2.
Assume in addition that each of the two countries has in total 36 million labor hours.
Wine Cars
France 5 hrs 16 hrs
Japan 9 hrs 18 hrs
a) Graph each country’s production possibility curve. Show the no-trade production point for
each country assuming that France consumes 1.2 million units of cars and Japan consumes 1.5
million units of wine.
Production possibility curve = combinations of wine and cars that can be produced with labor
endowment.
, ● France: 36 M hrs → max. 36/16 = 2,25 M cars or 36/5 = 7,2 M wine.
● Japan: 36 M hrs → max. 36/18 = 2 M cars or 36/9 = 4 M wine.
Under autarky: consumption = production.
● France: C = 1,2 → W = (36 - 1,2*16)/5 = 3,36.
● Japan: W = 1,5 → C = (36 - 1,5*9)/18 = 1,25.
b) When trade opens up at the international price 0.4C/W, what happens to production in each
country?
France: 5/16 = 0,3125 → price increases, production goes up
Japan: 9/18 = 0,5 → price falls, production goes down
France specializes completely in wine, Japan in cars.
c) Suppose that in the free-trade equilibrium, at a price of 0.4C/W, 1.2 million cars are traded.
What is the consumption point in each country under free trade? Show this graphically. How
can you “see” that both countries gain from trade?
● France: imports 1,2 M cars, exports 1,2/0,4 = 3 M wine.
Consumption: C = 1,2 W = 7,2 - 3 = 4,2
● Japan: exports 1,2 M cars, imports 3 M wine.
Consumption: W = 3, C = 2 - 1,2 = 0,8
Consumption points outside of the PPC → welfare gain.
3. Under competition, the real wage (wage/price) is simply equal to labor productivity, i.e. the
amount of output produced by one worker per hour of work. Using the labor hours needed to
produce wine and cars in France and Japan from question 2, answer the following questions.
Wine Cars
France 5 hrs 16 hrs
Japan 9 hrs 18 hrs
What is the effect of moving from autarky to free trade on consumer surplus and producer
surplus? What is the net national gain/loss?
Qd = 175 - P / 2
Qs = -100 + 5P
Price autarky = 50
World price (free trade) = 30
Gain consumer surplus: A + B1 + B2 + C
Producer surplus loss: A + B1
→ (50 - 30) x 50 = 1000 (A), 0,5 x (50 - 30) x (150
- 50) = 1000 (B1), 1000 + 1000 = 2000
Net (welfare) gain: B2 + C
→ 0,5 x (160 - 50) x (50 - 30) = 1100
,Week 2
1. There are two products, cars and wine, and two producers, France and Japan. Assume that it
takes France 16 hours to produce one car and 5 hours to produce one unit of wine. In Japan, it
takes 18 hours to produce one car and 9 hours to produce one unit of wine.
Wine Cars
France 5 hrs 16 hrs
Japan 9 hrs 18 hrs
a) Calculate the relative price of cars in France and Japan under autarky.
No money in autarky, so good 1 in terms of good 2. Relative price of cars = Pc/Pw →
#W/C
France: Pc/Pw = (16 hrs/car)/(5 hrs/wine) = 3,2 W/C
Japan: Pc/Pw = (18 hrs/car)/(9 hrs/wine) = 2 W/C
b) Which country has an absolute advantage in the production of cars, which country has an
absolute advantage in the production of wine? Which country has a comparative advantage in
the production of cars, which country has a comparative advantage in the production of wine?
France has an absolute advantage in producing wine and cars, Japan has a comparative
advantage in producing cars and France has a comparative advantage in producing wine.
c) When France and Japan open up to free trade, is it possible that the free-trade equilibrium
world price is 1.5W/C? Explain. If this is not an equilibrium price, should the price be higher or
lower than this level and which forces will bring about the required change in the price?
World price must be in between autarky prices (France: 3,2 W/C - Japan: 2 W/C).
● 1,5 W/C < 2 W/C: France wants to import cars, but Japan is not willing to sell.
● Excess demand for cars drives up the relative world price of cars until it falls in the range
(2 W/C, 3,2 W/C).
2. Take the labor hours needed to produce wine and cars in France and Japan from question 2.
Assume in addition that each of the two countries has in total 36 million labor hours.
Wine Cars
France 5 hrs 16 hrs
Japan 9 hrs 18 hrs
a) Graph each country’s production possibility curve. Show the no-trade production point for
each country assuming that France consumes 1.2 million units of cars and Japan consumes 1.5
million units of wine.
Production possibility curve = combinations of wine and cars that can be produced with labor
endowment.
, ● France: 36 M hrs → max. 36/16 = 2,25 M cars or 36/5 = 7,2 M wine.
● Japan: 36 M hrs → max. 36/18 = 2 M cars or 36/9 = 4 M wine.
Under autarky: consumption = production.
● France: C = 1,2 → W = (36 - 1,2*16)/5 = 3,36.
● Japan: W = 1,5 → C = (36 - 1,5*9)/18 = 1,25.
b) When trade opens up at the international price 0.4C/W, what happens to production in each
country?
France: 5/16 = 0,3125 → price increases, production goes up
Japan: 9/18 = 0,5 → price falls, production goes down
France specializes completely in wine, Japan in cars.
c) Suppose that in the free-trade equilibrium, at a price of 0.4C/W, 1.2 million cars are traded.
What is the consumption point in each country under free trade? Show this graphically. How
can you “see” that both countries gain from trade?
● France: imports 1,2 M cars, exports 1,2/0,4 = 3 M wine.
Consumption: C = 1,2 W = 7,2 - 3 = 4,2
● Japan: exports 1,2 M cars, imports 3 M wine.
Consumption: W = 3, C = 2 - 1,2 = 0,8
Consumption points outside of the PPC → welfare gain.
3. Under competition, the real wage (wage/price) is simply equal to labor productivity, i.e. the
amount of output produced by one worker per hour of work. Using the labor hours needed to
produce wine and cars in France and Japan from question 2, answer the following questions.
Wine Cars
France 5 hrs 16 hrs
Japan 9 hrs 18 hrs
