Question

What is absolute advantage in trade theory?

What is the comparative advantage on international trade?

How does absolute and comparative advantage lead to specialization?

What are the benefits of comparative advantage?

Calculations:

The following represents the production possibilities in the following two countries.

Canada                                                                                  Mexico
Good X	Good Y	Good X	Good Y
0	32	0	24
4	24	4	18
8	16	8	12
12	8	12	6
16	0	16	0

(a)            Which country has a comparative advantage at producing Good X?

(b)            How can you tell? (Hint: opportunity cost)

(c)            Which country has a comparative advantage at producing Good Y?

(d)            Indicate how both countries can gain from trade?

Use the following data to answer the following questions: Untied States can produce either 18 oranges or 9 apples in an hour, whereas, Mexico can produce either 16 oranges or 4 apples in an hour.

        2. What are the opportunity costs of producing 1 apple for United States and Mexico respectively?  

         3.  What are the terms of trade between apples and oranges that would allow both Untied States and Mexico to gain by specialization and exchange?

Answer 1

Solution

A country / firm is said to have an absolute advantage in trade if it is able to produce a more number of goods /amount of service than it's competitors / peers by utilizing the same amount of resources.

A country / firm is said to have an comparitive advantage in trade if it is able to a produce a good / render a service at a lower opportunity cost than it's competitors / peers.

In case of absolute advantage,since the country / firm has the lowest cost per unit,the demand for it's goods / service will be high,so it will start focussing and will produce more of that good / service.So,it specializes in producing that.In lon-run also it will improve due to reasons like learning curve,economic scale of production,increasing rate of return etc.,

In case of comparitive advantage,the country /firm will decide to produce the good/service if it has lower opportunity cost when compared to its competitors.

So,it's specialization will depend on more of it's relative performance with it's peers rather than it's own performance.

Both lead to specialization as they focus on more wealth maximization

(a) Canada has a comparitive advantage in producing a Good X

(b) The opportunity cost of producing good X is lower for Canada than Mexico .It can be seen that Canada needs to sacrifice 4 units of Good X inorder to produce 8 additional units of Good Y.But Mexico needs to sacrifice 4 units of Good X inorder to produce only 6 additional units of Good Y

(c) Mexico has a comparative advantage at producing Good Y

(d)Both countries can specilixe in producing the Goods they have comparitivev advantage.Canada can choose to specialize in producing Good X only and Mexico in producing the Good Y

2.The opportunity cost of producing 1 apple for United States is to sacrifice the production of 2 oranges.and the opportunity cost of producing 1 apple for Mexico is to sacrifice the production of 4 oranges.

3.The U.S must produce more of apples and Mexico must produce more of oranges.The terms of exchange can 1 apple for 3 oranges.so both the countries will benefit.

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