Question

Suppose that the United States and Saudi Arabia can each produce two products, oil and personal computers. The labor requirements per unit of output are provided in the table below.

Labor Requirements Per Unit of Output

	United States	Saudi Arabia
Oil	10	8
Personal Computers	30	4

Calculate the labor and opportunity costs for each good, and then compute each country’s absolute and comparative advantage. Use the results to determine what good each country should export and explain your reasoning

Answer 1

Let us compute the output table for both countries for output produced by 1 unit of labor.

	United States (US)	Saudi Arabia
Oil	1/10 = 0.100	1/8 = 0.125
Personal Computer (PC)	1/30 = 0.033	1/4 = 0.250

Since Saudi Arabia can produce more of both goods than US can (0.125 > 0.100, 0.250 > 0.033) using 1 unit of labor, Saudi Arabia has absolute advantage in both goods.

To find comparative advantage, we compute the Opportunity costs (OC).

In Saudi Arabia,

OC of Oil = 0.250 / 0.125 = 2 PC

OC of PC = 0.125 / 0.250 = 0.5 Oil

In US,

OC of Oil = 0.033 / 0.1 = 0.33 PC

OC of PC = 0.1 / 0.033 = 3 Oil

Since US can produce Oil at a lower OC than Saudi Arabia can (0.33 < 2), US has comparative advantage in Oil. Since Saudi Arabia can produce PC at a lower OC than US can (0.5 < 3), Saudi Arabia has comparative advantage in PC.

As per law of comparative advantage, a country should specialize in and export that good in which it has comparative advantage. Therefore,

US should specialize in & export Oil, and Saudi Arabia should specialize in & export PC.