1.3, 1.4, 1.5, 1.6, 1.

PROBLEMS ON COMPARATIVE
ADVANTAGE
 Problem#1.3: No Specialization and Trade
• Assume that China and France each have 1,000 production units. With
one unit of production inputs (a mix of land, labor, capital, and
technology), China can produce either 10 containers of toys or 7 cases of
wine.
• France, with one unit of production inputs, can produce either 2 cases of
toys or 7 cases of wine. Thus, a production unit in China is five times as
efficient compared to France when producing toys, but equally efficient
when producing wine.
• Assume at first that no trade takes place.
• China allocates 800 production units to building toys and 200 production
input units to producing wine.
• France allocates 200 production units to building toys and 800 production
input units to producing wine.
• What is the production and consumption of China and France without
trade?
 Problem#1.4: Each Country Specializes and
Trades
Assume complete specialization, where China produces only toys
and France produces only wine. What would be the effect on
total production?

Assumptions (containers/unit) (cases/unit)

China -- output per unit of production input 10 7
France -- output per unit of production input 2 7
China -- total production inputs 1000
France -- total production inputs 1000
 Problem#1.5: Terms of Trade
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 to France. Assume France produces 7,000 cases of
wine and exports 1,400 cases to China.
What happens to total production and consumption?
 Problem#1.6
• Continuing with the previous example, but France’s domestic
price is 2 ( instead of 10 in the earlier case) containers of toys
equals 7 cases of wine.
• Assume complete specialization.
• 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 of
a) China; and
b) France
 Problem#1.7
• Assume trade at Negotiated Mid-Price (6 toys = 7 wine)

• China exports 1200 containers of toys for 1400 containers of

wine.
#1.8. #1.9, #1.10
PROBLEM ON IMPACT OF FOREIGN
EXCHANGE CHANGES ON PRICES, SALES
AND FINANCIAL PERFORMANCE
 Problem# 1.8
• Peng Plasma is a privately held Chinese business. It specializes in the
manufacture of plasma cutting torches and export them to US buyers. Over
the past eight years it has held the Chinese renminbi price of the PT350
cutting torch fixed at Rmb 18,000 per unit.
• Over that same period it has worked to reduce costs per unit, but has
struggled of late due to higher input costs.
• Over that same period the renminbi has continued to be revalued against the
U.S. dollar by the Chinese government.
• Given the cost and exchange rates for various years in a table in the next slide
– assuming the same price in renminbi for all years – answer the following
questions:
a) What has been the impact of Peng's pricing strategy of “fixed renminbi
price” on the US buyers? How would you expect their U.S. dollar-based
customers to have reacted to this?
b) What has been the impact of “fixed renminbi price” policy on Peng's
margins?
 ……..Problem# 1.8

Average
Cost Price Rate
Year (Rmb) (Rmb) (Rmb/US$)
2007 16000 18000 7.61
2008 15400 18000 6.95
2009 14800 18000 6.83
2010 14700 18000 6.77
2011 14200 18000 6.46
2012 14400 18000 6.31
2013 14600 18000 6.15
2014 14800 18000 6.16
 Problem# 1.9
• Santiago Pirolta has accepted the Managing Director position for
Vitro de Mexico's U.S. operations. Vitro is a Mexico-based
manufacturer of flat and custom glass products. Much of its U.S.
sales are based on a variety of bottle products, both mass
market (e.g., glass bottles for soft drinks and beer) as well as
specialty products (high-end cosmetic bottles with rare metal
coloring and quality). He will live and work in the United States
(Dallas, Texas) and wishes to be paid in US dollars.
• Vitro has agreed that Santiago’s base salary of USD350,000 will
be paid in U.S. dollars, but Vitro wishes to tie his annual
performance bonus to percentage change in US sales, in the
Mexican pesos since Vitro being a Mexican company
consolidates all final results for reporting to stockholders in
Mexican pesos (MXN).
• Santiago, however, is a bit uncertain on having his bonus based
on the change in U.S. sales, in Mexican pesos. The sales
performance and exchange rates are given in the table
 Problem#1.10
Americo Industries
• Americo is a U.S.-based multinational manufacturing firm,
with wholly owned subsidiaries in Brazil, Germany, and China,
in addition to domestic operations in the United States.
Americo is traded on the NADSAQ.
• Americo currently has 650,000 shares outstanding.
• The basic operating characteristics of the various business
units is given in the Table on next slide
 Problem #1.10
Americo Industries

• Basic operating characteristics of the various

business units
  U.S. Parent Brazilian German Chinese
  Company Subsidiary Subsidiary Subsidiary
Business Performance (000s, local
currency) (US$) (reais, R$) (euros, €) (yuan, Y)
Earnings before taxes (EBT) $4,500 R$6,250 € 4,500 Y2,500
Corporate income tax rate 35% 25% 40% 30%
Avg exchange rate for the period 7.7500
foreign currency per USD (fc/$) ---- 1.8000 0.7018 
 Problem #1.10
Americo Industries
Americo must pay corporate income tax in each country in which it currently has
operations.
a) After deducting taxes in each country, what are Americo's consolidated earnings and
consolidated earnings per share in U.S. dollars?
b) What proportion of Americo's consolidated earnings arise from each individual
country?
c) Assume a major political crisis wracks Brazil, first affecting the value of the Brazilian
reais and, subsequently, inducing an economic recession within the country. What
would be the impact on Americo's consolidated EPS if the Brazilian reais were to fall
in value to R$3.00/$, with all other earnings and exchange rates remaining the same?
d) Assume a major political crisis wracks Brazil, first affecting the value of the Brazilian
reais and, subsequently, inducing an economic recession within the country. What
would be the impact on Americo's consolidated EPS if, in addition to the fall in the
value of the reais to R$3.00/$, earnings before taxes in Brazil fell as a result of the
recession to R$5,8000,000?
 Submit Solution in Microsoft
Word/Excel/PowerPoint file format
Happy Learning!