Question

Assume that in country A, the unit labor requirement for producing good X is 100 hours, and the unit labor requirement for good Y is 20 hours. Meanwhile in country B, the unit labor requirement for producing good X is 80 hours and the unit labor requirement for good Y is 40 hours. Answer the following:

1. Explain which country has an absolute advantage in each good.
2. Explain which country has a comparative advantage in each good.
3. Under the Theory of Comparative Advantage, explain the trade pattern between these countries.
4. Draw a Production possibilities curve for both countries (2 graphs, one for each country), given the above data. Show and explain how international trade could leave both countries better off than without any trade. Explain.

Answer 1

Hours required to produce

	X	Y
Country A	100	20
Country B	80	40

Let us assume each country has 400 million hours. Then total output of the two countries are

	X	Y
Country A	4 million units	20 million units
Country B	5 million units	10 million units

Country A has absolute advantage in production of good Y.

Country B has absolute advantage in production of good X.

Now calculating the opportunity cost

Opportunity Cost

	1 unit of X	1 unit of Y
Country A	5 units of Y	0.2 unit of X
Country B	2 units of Y	0.5 unit of X

Country A has comparative advantage in production of good Y, since its opportunity cost is less than that of country B.

Country B has comparative advantage in production of good X, since its opportunity cost is less than that of country A.

Country A will specialize in the production of good Y and Country B will specialize in good X. Country A will export Y and import good X. Similarly country B will export X and import Y.

Country A 25 15 10 0.5 1.5 2.5 3 3.5 4 4.5 2. 20

Country B

Country B 12 10 6. 4 3 6. 1,

Assume country A and B use 50% of the available labor hours to produce each good. Let us assume they agree to trade 1 unit of Good X for 2.5 unit of Y

	Country A		Country B
	X	Y	X	Y
Production	2	10	2.5	5
Consumption	2	10	2.5	5
After Specialization
Production	0	20	5	0
Trade affect	+2	-5	-2	+5
Consumption	2	15	3	5
Gain from trade	0	5	0.5	0

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