Question

1. Suppose there are two countries that have identical resources and technologies. Country A, using all of its resources, can either produce 10 pens or 5 books. Country B can produce, using all of its resources, either 9 pens or 3 books. Given this, answer the following questions: a. Which country has an absolute advantage in the production of pens and books respectively? Why? b. What is the opportunity cost of 1 book in country A and country B? Show all your work. c. Which country has a comparative advantage in the production of books? Why? Which country has a comparative advantage in the production of pens? Why? d. If allowed to trade, which country will export pens and which country will export books? Why? e. If trade occurred and 1 book was exchanged for 1 pen would both parties benefit from the exchange? If not, which party would not? Why? f. Economists often argue that trade improves the efficiency of the world economy. Assuming that complete specialization occurs, show in this example that trade would indeed improve the efficiency of the world economy.

Answer 1

Question 1

(a)

Both countries have identical resources and technologies.

A country is said to have absolute advantage in the production of a good when it can produce greater quantity of that good using same amount of resources relative to the other country.

Using all its resources in production of pens, Country A can produce 10 pens and Country B can produce 9 pens.

Using all its resources in the production of books, Country A can produce 5 books and Country B can produce 3 books.

Using the same quantity of resources, Country A can produce greater quantity of both goods relative to the Country B.

So,

Country A has an absolute advantage in the production of pens and books respectively.

(b)

Country A can produce either 10 pens or 5 books.

So,

The opportunity cost of 1 book in Country A is (10/5) 2 pens.

Country B can produce either 9 pens or 3 books.

So,

The opportunity cost of 1 book in Country B is (9/3) 3 pens.

(c)

Country A can produce book at lower opportunity cost relative to the Country B.

So,

Country A has comparative advantage in the production of books.

Country B can produce pens at lower opportunity cost relative to the Country A.

So,

Country B has comparative advantage in the production of pens.

(d)

A country exports that good in production of which it has comparative advantage.

Country A has comparative advantage in the production of books.

So,

Country A will export books.

Country B has comparative advantage in the production of pens.

So,

Country B will export pens.