Question

Consider the following production data for England and Portugal.

	England	Portugal
Labor force	25	200
Number of bottles of wine
per worker	40	50
Number of wheels of cheese
per worker	4	1

(a) Which country has an absolute advantage in the production of each good? Which country

       has a comparative advantage in the production of each good?

(b) Suppose prices/wages are in terms of wine. Assuming each country spends 50% income on cheese and 50% on wine, with no trade, what is the wage and price of cheese in

       each country? What is the total production of wine and cheese in each country?

(c) Suppose each country specializes in their comparative advantage good. After trade, what is the total global production of each good?

Answer 1

Solution:

(a)

Portugal has absolute advantage in production of each good. It can produce 200*50=10000 wine bottles as compared to 25*40=1000 wine bottles of England and 200*1=200 cheese wheel as compared to 25*4=100 cheese wheels of england.

Portugal has comparative advantage in producing wine as the labor is more efficient and can produce 50 bottles as compared to 40 bottles of england.

Whereas England has comparative edge in producing cheese wheel as each labor can produce as compared to 1 of Portugal.

(b)

Since prices are in terms of wine and each spends 50% on cheese. Money spent on cheese by England = 500. Production of cheese by 25 labors is 100 cheese wheel. Thus price per wheel $5(500/100) and labor cost $20(500/25).

Similarly Money spent on cheese by Portugal = 5000. Production of cheese by 200 labors is 200 cheese wheel. Thus price per wheel $25(5000/200) and labor cost $25(5000/200).

Total production in each country:-

England - Wine 1000 bottles & cheese 100 wheels

Portugal - Wine 10000 bottles & cheese 200 wheels

(c)

Total global production-

Cheese 100 wheels by england and wine 10000 bottles by portugal