Question

The US can make 60 units of wheat or 120 cars. Canada can make 160 units of wheat or 80 cars. What are the opportunity costs in each nation? Which nation has a comparative advantage in cars? In wheat? Imagine the two nations are not trading with easy other. The US produces and consumes 40 cars and 40 wheat. Canada produce and consumes 40 cars and 80 wheat. What is the total production of cars and wheat? Now suppose each nation specializes and only makes the product for which it has a comparative advantage. What is the new total production of cars and wheat? Next, suppose the US trades 60 units of the good it specializes in to Canada in return for 60 units of the good Canada specializes in. How much more or less can each nation consume compared to the situation in which it did not trade?

Answer 1

Solution:-

1. Opportunity cost is the value of next best alternative foregone.

U.S: 60 units of wheat = 120 cars

1 unit of wheat = 120/60 = 2 cars

Opportunity cost of 1 unit of wheat is 2 cars.

120 cars = 60 units of wheat

1 car = 60/120 = 0.5 units of wheat

Opportunity cost of 1 car is 0.5 unit of wheat.

Canada:

160 units of wheat = 80 cars

1 unit of wheat = 80/160 = 0.5 cars

Opportunity cost of 1 unit of wheat is 0.5 cars.

80 cars = 160 units of wheat

1 car = 160/80 = 2 units of wheat

Opportunity cost of 1 car is 2 unit of wheat.

2. A country has a comparative advantage in producing that good if the opportunity cost of producing that good is lower in that country as compared to another country.

Opportunity cost of producing wheat is less when it is produced by Canada so Canada has comparative advantage in the production of wheat while US has comparative advantage in the production of cars.

3. Total production of cars = Cars produced by US + Car produced by Canada = 40 + 40 = 80 cars

Total production of wheat = 40 units + 80 = 120 units

4. After specialization, the U.S produced only cars,

Total production of cars = 120 cars

Canada will only produce wheat, total production of wheat = 160 units of wheat

5. After trade:

The US - Wheat = 0 + 60 = 60 units

Cars = 120 - 60 = 60

Canada - Wheat = 160 - 60 = 100 units

Cars = 0 + 60 = 60

So, Increase in consumption of cars by U.S = 60 - 40 = 20

Increase in consumption of wheat by U.S = 60 - 40 = 20 units

Increase in consumption of cars by Canada = 60 - 40 = 20

Increase in consumption of wheat by Canada = 100 - 80 = 20units