Econ130 Tutorial 6

International Trade; Finance

Part 2: Multi-Choice

MC1. (d)

MC2. (c)

MC3. (b)

Part3: Structured questions

Q1. Benefits of Trade

Grapes Wool
Country A 200 400
Country B 400 400
Total 600 800
Opportunity cost of grapes Opportunity cost of wool
Country A 2 0.5
Country B 1 0.1

1.

a)

Country A exports wool because they have a comparative advantage in wool OC A = 0.5 while OCB =
0.1. Country B exports grapes because they have a comparative advantage in grapes OC B = 1 while
OCA = 2. PPF with trade is kinked at 400 so the PPF has two different slopes which reflect each
country’s opportunity costs.

b)
Econ130 Tutorial 6

Conditions for equilibrium

 Aggregate production = Aggregate expenditure i.e. demand = supply

 Consumption and production decisions to maximise the utility of individual households.

Complete specialisation means each country produces only the good that they have comparative
advantage in. Total output or production = 400 and the total consumption = 400. Each household
has 400 labour hours and there are 400 households. Each household income is 1 (equilibrium price *
unit of labour = 1*1 = 1). Each household spends half their income on each good i.e 0.5 on grapes
and 0.5 on wool.

Country A Country B

Aggregate production (AP) 400w 400 g

Aggregate consumption (AC) 400*0.5w = 200w 400*0.5w = 200w

400*0.5g = 200g 400*0.5g = 200g

Total = 400 Total = 400

Equilibrium AP = 400, AC = 400 AP = 400, AC = 400

c)

Before trade:

If A splits production equally between grapes and wool, they will produce 100g and 200w.

If B splits production equally grapes and wool, they will produce 200g and 200w.

After trade:

 Each household consumes 200w and 200g in both countries. This means that the households
in country A can consume 100 more grapes and would be better off, while B is no better or
worse off (they are still consuming 200 grapes and 200 wool before and after the trade.
 Not necessarily every individual will be better off after trade – there are winners and losers.

Q2. NPV

 Present Value (PV) is the amount needed today given a particular interest rate to produce a
future sum. Future Value (FV) is the value of an investment at a specific date in the future
given a particular interest rate. Net Present Value (NPV) is the difference between the PV of
revenues and the PV of the costs (i.e. sum of the discounted profits).
 PV = [1/ (1+r)t-1] FV
 Example for Firm A invests, Firm B invests on board
 PV in year 1 = -30, PV in year 2 = 54.54, PV in year 3 = 49.59
NPV = PV in year1 + PV in year 2 + PV in year 3 = 74.13

Discount
rate 10%

Firm A invests, Firm B invests Firm A invests, Firm B doesn't invest

Year 1 2 3 Sum Year 1 2 3 Sum
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6 6
Revenues 20 0 0 140 Revenues 20 20 0 -60
Costs -50 0 0 -50 Costs -50 -10 0 -20
Profit -30 90 Profit -30 10 0 -80
-30 5 5 74 -30 9 0 -21
Discounted 5 0 Discounted

Firm A doesn't invest, Firm B doesn't

Firm A doesn't invest, Firm B invests invest
Year 1 2 3 Sum Year 1 2 3 Sum
40 2 0 60 10 10 0 20
Revenues 0 Revenues
Costs 0 -5 0 -5 Costs 0 0 0 0
40 1 0 55 0 10 0 20
Profit 5 Profit
40 1 0 54 10 9 0 19
Discounted 4 Discounted