Question

Consider the following information on the production possibilities frontier for each country;

Spain produces 300 Sweetwaters and 100 Potatoes

Ireland produces 400 Sweetwater and 200 Potatoes

a. Find the opportunity cost of Sweetwater in Spain and explain its meaning.

b. Find the nation with a comparative advantage in Sweetwater and show why. Which country has the absolute advantage in Sweetwater?

c. Suppose Ireland is currently producing 200 Sweetwater and 100 potatoes the trading ratio is equal to 2.5 Sweetwater per potato. If Ireland begins to specialize in its good of comparative advantage by producing 10 more units of that good, will it gain from trade with Spain? Show why or why not by completing the table below:

Ireland Sweetwater Potatoes

1. Before trade

2. With some specialization

3. After trade

Answer 1

(a)

Opportunity cost of producing one sweet water in Spain is 100/300 potatoes = 1/3 potatoes

This means that its pain wants to produced one sweet water it has to give up 1/3 potato.

(b)

Opportunity cost of producing One sheet water in Ireland is 200/400 potatoes = 1/2 potato.

Since opportunity cost of producing one sweetwater in Ireland is higher than the opportunity cost of producing one sweetwater in Spain. Spain has a comparative advantage in producing Sweetwater.

Spain can produce 300 sweet water while Ireland can produced 400 Sweetwaters. Hence Irelnd has a absolute advantage in producing Sweetwaters.

(c)

Since spain has a comparative advantage in producing sweetwater ireland must have comparative advantage in producing potatoes.

We know that a country specialises in the commodity in which it has comparative advantage, hence Ireland will export potatoes to Spain in exchange for Sweetwater.

Is the opportunity cost of producing one sweetwater in Ireland is half potatoes. The opportunity cost of producing one potato will be 2 Sweetwaters. So the opportunity cost of producing 10 potatoes will be 20 Sweetwaters.,

When Ireland specializes, if it produces 10 more units potatoes it will have to decrease its production of Sweetwaters by 20 units.

We are given that the trading ratio is 2.5 sweetwater per potato.

So if Ireland gives up 9 units of potatoes to Spain, it will get 9*2.5 = 22.5 units of Sweetwaters.

Ireland!	sweetwater	potato
Before trade	200	100
With some specialization	180	110
After trade	180+22.5 = 202.5	110-9 = 101

Thus, by trading Ireland will have 1 extra unit of potato and 2.5 extra units of Sweetwaters. Hence we can save that Ireland will gain from trade with speed