Question

Review Handout | Absolute Advantage and Comparative Advantage | Cases 1-3 (3 pages)

*Holding other things constant and considering the usual assumptions for the 2C-2G-1F model and production per unit of labor for both Case 1 and Case 2 below, determine which country has the absolute advantage and comparative advantage in which good.

Example Case 1

Country	Good X	Good Y	Opp. Cost of X in term of Good Y?	Opp. Cost of Y in terms of Good X?
Country A	60 60 /60 =1 60/80 = 3/4	80 80 /60 =4/3 80/80 = 1	4/3 (=1.33)	¾ = 0.75
Country B	35	70

To determine who has a comparative advantage in which good, we will need to calculate opportunity costs of good X and good Y in each country first.

In the case of Country A above, the opp. cost of X (in terms of Y) is the number of units of Good Y Country A should give up in order to produce one more unit of Good X.   To find out this, we can simply divide the number of Good X and Good Y per unit of labor in each cell by 60, respectively, so that we can see how many units of Good Y Country A should give up to produce one more unit of Good X in Country A.   As shown above, it will be 1.33.  

By the same token, in the case of Country A, the opp. cost of Y (in terms of X) is the number of units of Good X Country A should give up in order to produce one more unit of Good Y.   To find out this, we can simply divide the number of Good Y and Good X per unit of labor in each cell by 80, respectively, so that we can see how many units of Good X Country A should give up to produce one more unit of Good Y in Country A.   As shown above, it will be 0.75.  

1. Which country has an absolute advantage in producing X and Y, respectively?

Hint) Per unit of labor, which country is producing Good X (Good Y) more in absolute terms?

2. Country A has a comparative advantage in producing:

3. Country B has a comparative advantage in producing:

Case 2

Country	Barrels of Wine	Bales of Wool	Opp. Cost of Wine?	Opp. Cost of Wool?
Portugal	20	20
The U.K.	40	80

1. Which country has an absolute advantage in producing wine and wool, respectively?

2. Portugal has a comparative advantage in producing:

3. The U.K. has a comparative advantage in producing:

Case 3. Now assume that country “American” can produce either 20 songs or 40 boxes of roses per week. Assume that country “Eagle” can produce 10 songs or 50 boxes of roses per week. Consider the usual assumptions holding other things constant.

Country	Songs	Roses	Opp. Cost of Songs	Opp. Cost of Roses
American	20	40
Eagle	10	50

1. Which has a comparative advantage in the production of songs?

2. Which has a comparative advantage in the production of roses?

3. If each produces songs for one week and then roses for one week, show the total    production of both goods.

Country	Songs	Roses
American
Eagle
Total

4. Now, assume each country specializes for two weeks. Indicate the total production of both goods. Show that trade between the two countries after this two-week period can allow both countries to consume both more roses and songs.

Country	Songs	Roses
American
Eagle
Total

Answer 1

Case1-

Opportunity cost for Country A for good X=80/60=1.33 units of Y, for good Y=60/80=0.75

For country B opportunity cost for X=70/35=2 units of Y, for good Y=35/70=1/2=0.5

Since Country A has comparative advantage in producing good X as opportunity cost in terms of Y is lower in country A

Country B has comparative advantage in producing good Y as opportunity cost is lower for Y when compared to country A

Country A has comparative advantage in producing both X and Y as it produces more of both X and Y with same labor

Case2-

For Portugal opportunity cost of producing wine=20/20=1 bales of wool, for producing wool=20/20=1 Barrell of wine

For UK, opportunity cost of producing wine=80/40=2 bales of wool, for wool=40/80=0.5 barrells of wine

So, Portugal has comparative advantage in producing Wine as the opportunity cost in terms of wool is lower than UK for wine manufacturing whereas UK has comparative advantage in manufacturing of wool as opportunity cost in terms of wine is lower for UK when compared with Portugal for manufacturing of wool

UK has the absolute advantage in manufacturing both wool and wine as it can manufacture both wool and wine higher when compared to Portugal with all other factors being equal

Case3-

American opp cost of songs=40/20=2 roses,opp cost of roses=20/40=0.5 songs,

For Eagle opp cost of song=50/10=5 roses ,opp cost of roses=10/50=0.2 songs

Hence, American have comparative advantage in songs(opp cost of 2 against 5 in Eagle) whereas Eagle have comparative advantage in Roses

As for Absolute advantage American have that for Songs (20 against 10 for eagles) all other factors being equal and Eagles have in Roses(50 against 40 for American) with all other factors being equal

If each country produces song for one week and roses another week total production for American=20 songs and 40 roses and for Eagles=10 songs and 50 roses so Total production =20+10=30 songs,40+50=90 Roses

Basis specialization American will produce songs basis their absolute advantage and eagles will produce roses

Total production of songs=20*2=40 and roses=50*2=100

Now if they trade, America can keep 25 songs and 15 trade to Eagles in exchange of 45 roses,

So America will have 25 songs,45 roses and Eagles will have 15 songs and 100-45=55 roses and hence both countries can consume higher if they would have not traded