Suppose labor productivity in France is such that one hour of labor is required to produce one gallon of wine while two hours of labor are required to produce one pound of cheese. Assuming the availability of one million labor hours, draw a constant-cost production-possibility curve for France with the quantity of cheese measured along the vertical axis and the quantity of wine on the horizontal axis. If the free-trade price of wine is two pounds of cheese per gallon, show where, with free trade, France will produce on its production-possibilities curve. Then, draw and use a trade line to illustrate how France can gain from free trade.
What will be an ideal response?
POSSIBLE RESPONSE:
If France produces only cheese, with one million labor hours France will be able to produce half a million pounds of cheese. If France produces only wine, France will be able to produce one million gallons of wine. The production-possibility curve for France is a straight line as shown in the graph. The opportunity cost of one gallon of wine in France is half a pound of cheese. In the international market, one gallon of wine is exchanged for two pounds of cheese, which is higher than the opportunity cost of wine production in France. This implies that it will be beneficial for France to produce only wine and trade it for cheese instead of producing cheese itself. With free trade France can consume any combination of quantities of wine and cheese lying on the trade line shown in the graph. France gains from trade because these combinations lie clearly beyond France's production-possibility curve, which means they are unattainable under autarky.
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