Question

Man Hour Required to Produce Unit of Output

                               Country A            Country B

                    Good X         3                    12

                    Good Y         2                    14

1. What will be the post-trade price ratio or international terms of trade?

2. Which country would prefer an international terms of trade of 9? 6? Why?

3. Given that wages are fixed in each country at W_A = 5 and W_B = 2, what is the limit within which exchange rate can fluctuate in order for comparative advantage to assert itself.

4. Which country has comparative advantage in which good? Why?

Answer 1

Sol: Post-trade price ratio is equal to the opportunity cost of producing both the goods by country A and B

Let Country A be home country and Country B be a reign country, than post-trade price ratio

for Country A for good X and good Y: Py/Px= 2/3

for country B for good X and good Y: 14/12= 7/6

b) Country whose post-trade price ratio is lower will prefer international terms of trade of 9

The country with a higher post-trade ratio will prefer international terms of trade of 6.

c) total cost for Country A for producing Good X will be: Wa * Mh=3*5= 15

the total cost of producing GoodY by country A will be: 2*5=10

so, the limit will be (GoodX, Good Y) :(15,10)

The total cost of producing Good X for country B: 2*12= 24

The total cost of producing Good Y for Country B: 2*14= 28

so, the limit will be ( 24, 28)

d) Country A will have a comparative advantage in Good Y as the production cost is less

Country B will have a comparative advantage in Good X.