Question

Consider the following (assume that there are 2 workers in Mexico and 3 in the USA):

Bottles of tequila produced in one hour Mexico, 8 USA, 4

4 Pounds of rice produced in one hourMexico, 6 USA, 8

From the above table, select the correct answer:

A) The pre-trade relative price of tequila in the USA is 2 and in Mexico is 0.75 and therefore the USA has a comparative advantage in rice

B) The pre-trade relative price of rice in the USA is 0.5 and in Mexico is 1.33 and therefore Mexico has a comparative advantage in rice

C) The pre-trade relative price of tequila in Mexico is 0.75 and in the USA is 2 and therefore Mexico has a comparative advantage in rice

D) The pre-trade relative price of tequila in the USA is 0.75 and in Mexico is 2 and therefore USA has a comparative advantage in rice

Answer 1

The answer is A) The pre-trade relative price of tequila in the USA is 2 and in Mexico is 0.75 and therefore the USA has a comparative advantage in rice

Explanation

                     Tequila(Bottles)             Rice(Pounds)

USA                   4                                          8

Mexico               8                                          6

It is seen that, if the USA decides to produce only Tequila, it has to give up double the units of Rice, whereas to produce additional pound of Rice, it has to give half a bottle. Hence the opportunity cost of producing Rice is less ie half a bottle rather than producing an additional bottle of tequila. Hence USA has comparative advantage in Rice and Mexico in Tequila.

In terms of rice (opportunity cost), the price of Tequila in USA is 2 (8/4) pounds of Rice & in Mexico it is 0.75(6/8).