Question

Paul and Tim inhabit a two person world and they could only produce and consume two goods: cigars and oranges. They both face constant returns to scale. Below is a table that show the production possibilities for both Paul and Tim if they are to fully specialize in each good only: Paul Tim Cigars only 50 100 Oranges only 200 250 a. Who has an absolute advantage in producing cigars? Who has the comparative advantage in producing cigars? b. Who has an absolute advantage in producing oranges? Who has the comparative advantage in producing oranges? c. Predict the pattern of trade and the range of prices for which we could expect trade between Paul and Tim

Answer 1

From the question, we know that Paul can produce 50 cigars only or 200 oranges only. Tim can produce 100 cigars only and 250 oranges only.

a) We can say that Tim has an absolute advantage in the production of cigars because he can produce more cigars than Paul.

We can also say that Tim has an absolute advantage in the production of oranges because he can produce more oranges than Paul.

b) The opportunity cost of producing cigars for Paul = 200/50 = 4 oranges.

The opportunity cost of producing cigars for Tim =

= 250/100 = 2.5 oranges.

The opportunity cost of producing oranges for Paul = 50/200 = 0.25 cigars

The opportunity cost of producing oranges for Tim =

= 100/250 = 0.4 cigars.

We can say that Tim has a comparative advantage in the production of cigars because the opportunity cost of producing cigars for Tim is less than the opportunity cost of producing cigars for Paul.

We can also say that Paul has a comparative advantage in the production of oranges because the opportunity cost of producing oranges for Paul is less than the opportunity cost of producing oranges for Tim.

c) So, we can say that Paul will specialize in the production of oranges and export oranges whereas, Tim will specialize in the production of cigars and export them. The range of trade price would be between 2.5 oranges to 4 oranges in exchange for 1 cigar. This is because Tim can produce 2.5 oranges by sacrificing the production of 1 cigar. So, he will require more than 2.5 oranges for each cigar he gives to Paul. In the same way, Paul can produce 1 cigar by sacrificing the production of 4 oranges. So, Paul would trade if he can get a cigar by giving less than 4 oranges.

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