Question

1. 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?

Answer 1

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

Calculating the opportunity cost

	Good X	Good Y
Canada	2 units of Y	0.5 unit of X
Mexico	1.5 units of Y	0.67 unit of X

a. Mexico has a lower opportunity cost of producing good X. Thus, Mexico has comparative advantage in producing good X.

b. The opportunity cost to produce is low for Mexico in case of good X and in case of good Y Canada has comparative advantage.

c. Canada has comparative advantage in producing good Y.

d. When they will specialize then both the countries would get benefitted. The two countries will be producing only that good in which they specialize. Canada will produce only Good Y and Mexico will produce only good X.

Both countries will be ready to trade when they exchange 1 unit of X for 2 units of Y.

Canada will be ready to trade when it has to sacrifice less than 2 unit of Y for 1 unit of X. Similarly Mexico will be ready to trade when it receives more than 1.5 units of Y for 1 unit of X.

Term of trade will be exchange 1 unit of X for 1.75 unit of Y.

Let us assume currently Canada is consuming 4 units of X and 24 units of Y.

Mexico is consuming 12 units of X and 6 units of Y.

After trade they agree to exchange 4 units of X for 8 units of Y.

	Canada	Canada	Mexico	Mexico
	X	Y	X	Y
Production	4	24	12	6
Consumption	4	24	12	6
Trade
Production	0	32	16	0
Term of trade	+ 4	- 7	- 4	+ 7
Consumption	4	25	12	7
Gains from trade	0	1	0	1

From above table we can see both countries get benefited through trade.

This table deviates thus I have typed countries name in both blanks.