Question

Suppose there are two countries – Home and Foreign – that produce only coffee and sugar. It takes home workers three hours to produce a bag of coffee; and four hours to produce a bag of sugar. Foreign country is less productive – their workers spend seven hours to make a bag of coffee and a half of a day (twelve hours!) to eventually produce a bag of sugar.

1. Which country has an absolute advantage in coffee? Sugar? Explain intuition in 1-2 brief sentences

2. Which country has a comparative advantage in coffee? Sugar? Explain intuition in 1-2 brief sentences

3. Suppose Foreign country made a technical innovation which improved productivity there by one-third. In other words, foreign workers now spend one-third less time producing a bag of sugar than previously. How does your answer for part b) change?

4. Inspired by sugar producers, Foreign country created packaging technology that allowed them to decrease time to produce a bag of coffee by an hour. How does you answer to part b) change after both improvements?

5. The flow of history was exceptionally unsuccessful for Home country – it was colonized, and home worker morale decreased. As a result, Home country lost most of the mechanical innovations and their productivity become three times slower (i.e. both production times were tripled). Likewise, Foreign country kept all improvements discussed in the previous parts. How do your answers for both parts a) and b) change?

Answer 1

Answer:

Labor hours are allocated in both countries for both products as given in the table below:

	Home	Opportunity cost	Foreign	Opportunity cost
Coffee	3	3/4 or 0.75 sugar	7	7/12 or 0.58 sugar
Sugar	4	4/3 or 1.33 coffee	12	12/7 or 1.71 coffee

1)

Home country has absolute advantage in production of both coffee and sugar because it can produce both goods in less time as compared to foreign country.(3<7) and (4<12).

2)

Opportunity cost is the sacrifice of one product made to produce another product. Here, opportunity cost of Coffee is less in Foreign country (0.58<0.75) so it has comparative advantage in production of coffee and Home country has comparative advantage in production of Sugar(1.33<1.71).

3)

With technical innovation new Labor hour allocation in both countries for both products as given in the table below:

	Home	Opportunity cost	Foreign	Opportunity cost
Coffee	3	3/4 or 0.75 sugar	7	7/8 or 0.87 sugar
Sugar	4	4/3 or 1.33 coffee	8(12-1/3*12)	8/7 or 1.14 coffee

Now, opportunity cost of Coffee is less in Home country (0.75<0.87) so it has comparative advantage in production of coffee and Foreign country has comparative advantage in production of Sugar(1.14<1.33).

4)

After inspiration from sugar producers Labor hour allocation in both countries for both products as given in the table below:

	Home	Opportunity cost	Foreign	Opportunity cost
Coffee	3	3/4 or 0.75 sugar	6(7-1)	6/8 or 0.75 sugar
Sugar	4	4/3 or 1.33 coffee	8	8/6 or 1.33 coffee

Now, both countries have same opportunity costs for both products. So, no country has comparative advantage in any good.

5)

After colonization, Labor hour allocation in both countries for both products as given in the table below:

	Home	Opportunity cost	Foreign	Opportunity cost
Coffee	9	9/12 or 0.75 sugar	6	6/8 or 0.75 sugar
Sugar	12	12/9 or 1.33 coffee	8(12-1/3*12)	8/6 or 1.33 coffee

Now, both countries have same opportunity costs for both products. So, no country has comparative advantage in any good. But now Foreign country can produce both goods in less time as compared to home country. So, Foreign country has absolute advantage in production of both goods.