Question

1. Using their available amount of resources, USA and Canada can each produce oranges and salmonberries as shown in the following table, measured in thousands of bushels (assume these are the only combinations that could be produced).

USA		Canada
oranges	salmonberries	oranges	salmonberries
12	0	6	0
3	3	3	3
0	4	0	6

1. Which country has the comparative advantage in producing salmonberries? Which one has the comparative advantage in producing oranges? Explain. (1)

2. Suppose that each country is currently producing 3 thousand bushels of salmonberries and 3 thousand bushels of oranges. Show that both can be better off if they specialize in producing one good and then engage in trade. (1)

Answer 1

a) Note that the opportunity cost of producing 1 salmonberry is 12/4 = 3 oranges in the US and 6/6 = 1 orange in Canada. Hence, the Canada has a lower relative opportunity cost in the production of salmonberry.

Thus, Canada has the comparative advantage in producing salmonberries and the US has the comparative advantage in producing oranges. This is based on the law of opportunity cost and specialization.

b) Suppose that each country is currently producing 3 thousand bushels of salmonberries and 3 thousand bushels of oranges. After specialization, the US produces 12 thousand oranges and no salmonberries while Canada produces 6 thousand salmonberries and no oranges. Terms of trade lie between the two opportunity costs.

Let’s assume that the terms of trade are 3 thousand salmonberries for 6 thousand oranges. Then the US has (12 – 6) = 6 thousand oranges and 3 thousand salmonberries while Canada has (6 – 3) = 3 thousand salmonberries and 6 thousand oranges. Clearly, the US has more oranges and same salmonberries while Canada also has more oranges and same salmonberries. Both can be better off if they specialize in producing one good and then engage in trade.