Question

In: Economics

Suppose Spain can produce 1200 pounds of olives or 1600 pounds of tomatoes each week and...

  1. Suppose Spain can produce 1200 pounds of olives or 1600 pounds of tomatoes each week and that Italy can produce 800 pounds of olives or 800 pounds of tomatoes each week.
  1. Which country has the absolute advantage in olives? Which country has the absolute advantage in tomatoes?
  2. If the Theory of Comparative Advantage is utilized what good(s) will each country produce and how many of that good will be made by each country?
  3. What if the introduction of new agricultural technology allows Italy to increase specialized production of each good; boosting olives by an additional 800 pounds or tomatoes by 600 pounds? Now which country would have the comparative advantage in each good and show what the calculated opportunity cost is for each country/good.

Solutions

Expert Solution

a) A country is said to have an absolute advantage if the country can produce a good at a lower cost than another. Spain can produce both the goods at a lower cost than Italy. Spain produces 1200 pounds of olive or 1600 pound of tomatoes both of which are more than the what is produced in Italy. So Spain has absolute advantage in both the goods.

b) Comparative advantage is when the opportunity cost of producing the good is less than other countries. In case of olives , Spain has to forgoe 1600 pounds of tomatoes for 1200 pound of olive . So opportunity cost of 1 pound of olive is 1600/1200 or 4/3 pound of tomatoe. Similarly for Italy , opportunity cost of 1 pound of olive is 800/800 or 1 pound of tomatoe

So Italy has a lower opportunity cost in olives and hence would produce olives . SImilarly Spain has a lower opportunity cost in tomatoes ie 3/4 and Italy a higher opportunity cost. So Spain produces tomatoes.

c) If Italy decides to increase production of olives by 800 , the total would be 1600 pound of olive and now the comparative advantage of producing olives would be with Italy because now the opportunity cost of producing olives is less .

Italy produces 1600 pounds of olive or 800 pound of tomatoes . So 1 pound of olive is produced at sacrificing 1/2 pound of tomnatoes while 4/3 is opportunity cost is for Spain . So now Italy produces olive and Spain tomatoes.

In other case if instead 600 more tomatoes are to be produced , then total 1400 tomatoes would be produced and opportunity cost would be 800/1400 or 4/7 which is lower than of Spain . So in this case Italy would produce tomatoes and Spain olives because Italy has comparative advantage in tomatoes.

(You can comment for doubts )


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