Question

Suppose there are only two countries in our world – Z and E. Country Z and E both have the ability to produce two goods, wire and sand. In a year Z can produce 100 wire OR 500 sand while E can produce either 150 wire OR 400 sand.

1. Assume currently each country spends half the year producing wire and half the year producing sand – would specialising and trading help both of these countries? Explain.

2. Graphically represent your answer for 1.

Answer 1

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	Wire	Sand
Counrty Z	100	500
Counrty E	150	400

1 unit of wire = 500/100 = 5 unit of sandThe opportunity cost of production in Z =>

Terms of trade in the domestic market => 1 wire= 5 Sand

similarly => 1 unit of sand  = 100/500 unit of wire

1 sand = 0.2 wire

In-country E

1 unit of wire =400/150

1 unit of wire = 2.67 unit sand

similarly

1 unit sand =150/400

1 unit sand =0.375 units of wire

so Z has an absolute advantage in the production of sand and E has an absolute advantage in the production of wire.

Country Z can produce 500 units of sand and Country E can produce 150 units of wire under specialization in the commodity in its absolute advantage.

In-country Z domestic market is ready to exchange 5 sand in exchange of only 1 wire whereas in-country E domestic market one unit wire exchanged by only 2.67.

After specialization Under free trade, Z has a chance to exchange 1 unit of wire in less than 5 units of sand whereas E has a chance to exchange 1 unit of wire and get more than 2.67units of sand under the international market at international Terms of trade.
So, Under specialization, both countries have beneficial trade.