Question

Consider an economy with two countries, Alpha and Beta. In Alpha, Computers cost $600 to produce, and Cell Phones cost $150 to produce. In Beta, Computers cost $750 to produce, and Cell Phones cost $250 to produce. Both countries are operating efficiently and with closed trade borders. If these countries agree to open their borders and trade with one another, is it possible for them to find a mutually beneficial trade agreement? If so, who will focus on computers and who will focus on cell phones? Use detailed explanations of comparative advantage and the opportunity costs in this scenario to explain your answers.

Answer 1

Answer: We know that opportunity cost is defined as the amount of good Y that we need to give up for an additional unit of good X. Here the two goods of our interest are cell phones and computers.

In country alpha, the cost of producing one computer is $600 and the cost of producing one cell phone is $150. This means the cost of producing an extra unit of computer is four times higher than the cost of producing a cell phone in alpha.

For country beta, the cost of producing one computer is $750 while one cell phone is $250. This means here the cost of producing an extra unit of computer is three times higher than the cost of producing cell phone in beta. Here since the cost of production of one more unit of computer is lower for beta, country beta must specialize in producing computer.

Similarly the cost of producing an extra unit of cell phone is 1/4th (150/600) of the cost of producing a computer in alpha. While the cost of producing an extra unit of cell phone is 1/3rd (250/750) of the cost of producing a computer in beta. Here since the cost of producing cell phone in terms of computer is lower for alpha, country alpha should specialize in cell phones.