Risk Management and Derivatives (723G33)

ANOUAR SOLDI

Assumptions Prod. Units Toys Wine (cont/unit) (case/unit) China (C) 1,000 10 7 France (F) 1,000 2 7

1. Production and Consumption. What is the production and consumption of China and France without trade?

Production without trade Toys Wine China 10x800=8,000 7x200=1,400 France 2x200= 400 7x800=5,600

Total prodct & conspt (F+C) 8,400 7,000

2. Specialization. Assume complete specialization, where China produces only toys and France produces only wine. What would be the effect on total production?

China 10x1,000= 10,000 toys France 7x1,000= 7,000 wine

After specialization the total production of toys is 10,000 compared to 8,400, thus it will be produced 1,600 more containers of toys, whereas the production of wine will remain the same – 7,000.

3. Trade at China’s Domestic Price. China’s domestic price is 10 containers of toys equals 7 cases of wine. Assume China produces 10,000 containers of toys and exports 2,000 containers to France. Assume France produces 7,000 cases of wine and exports 1,400 cases to China. What happens to total production and consumption?

Toys Wine Prod Exp Dom Prod Exp Dom

C 10,000 2,000 8,000 F 7,000 1,400 5,600 Compared to the production and consumption before trade, France consumption of toys increases from 400 containers to 2,000 containers, thus an increase of 1,600 containers, while in the case of wine the quantity remains the same. China’s production and consumption of toys and wine remains at the same levels before and after trade. Thus the trade benefits France.

4. Trade at France’s Domestic Price. France’s domestic price is 2 containers of toys equals 7 cases of wine. Assume China produces 10,000 containers of toys and exports 400 containers to France. Assume France in turn produces 7,000 cases of wine and exports 1,400 cases to China. What happens to total production and consumption?

C 10,000 400 9,600 F 7,000 1,400 5,600

In the case of China the production and consumption of toys after trade rises to 9,600 containers – up with 1,600 containers compared to before trade production and consumption, while France remains at the same level, 400 containers. In case of wine production and consumption the levels remain the same as to prior to trade. Therefore China is benefiting from trading at the levels of Frances domestic prices.

5. Trade at Negotiated Mid-price. What happens to total production and consumption?

C 10,000 1,200 8,800 F 7,000 1,400 5,600

Compared to the situation prior to trade – China increases with 800 containers of toys- from 8,000 containers of toys prior to 8,800 post- trade, while the wine level remains the same. France post-trade has 800 containers of toys more, from 400 to 1,200, while the level of wine remains the same. At the negotiated mid-price the 1,600 containers of toys (10,000 production + consumption after trade - 8,400 prior to trade) are divided equally between the two countries.