Question

	Country A	Country B
Soybeans	6	12
Textiles	6	8

Suppose that w_b=Peso 1000 and e=2 (e is the exchange rate). What is the maximum level of w_a (expressed in $) such that these 2 countries trade according to Comparative Advantage?

a) 1500

b) 2666

c) 4000

d) 8000

Answer 1

Solution:- (B) 2666

Explanation:-

=> Comparative advantage in terms of soybeans:-

*Country A: 3 soybeans = 6 textile so 1 soybeans = 6/3 textile = 2 textile

*Country B:12 soybeans = 8 textile so 1 soybeans = 8/12 textile = 0.66 textile

It shows that the opportunity cost of producing soybean is less in country B than country A so country B has comparative advantage in producing soybean instead of textile

=> comparative advantage in terms of textile:-

*country A: 6 textile = 3 soybeans so 1 textile = 3/6 soybeans = 0.5 soybeans

*Country B: 8 textile = 12 soybeans and 1 textile = 12/8 soybeans = 1.5 soybeans

It shows that the opportunity cost of producing textile is less in country A than country B so country A has comparative advantage in producing textile instead of soya bean

=> Total welfare in production of good in country A= 8*3 = 24 whereas Total welfare in production of good in country B = 12*6 = 72

In the case of exchange welfare in both country = 1000 / 24 = 46.66

=> equity in exchange = 46.66*100 = 4666

so net welfare = 4666 - (1000*2)

= 2666

so the maximum level of welfare is 2666 according to these two countries.