Question

What would a (hypothetical) numerical example of comparative advantage for the two country two good one factor case? Demonstrate how both countries gain from trade.

Answer 1

Suppose there are two countries :Saudi arabia and United states ,

Two goods : Oil and corn ,

One factor: Labor hours.

Using 100 labor hours , each country's production possibilities is shown in the below table:

Country	Oil production	Corn production
Saudi arabia	100	25
United states	50	100

Opportunity cost of producing barrels of oil Saudi arabia = 25/100 =1/4 bushles of corn.

Opportunity cost of producing bushels of corn in Saudi arabia =100/25= 4 barrels of oil.

Opportunity cost of producing barrels of oil in United states = 100/50 = 2 bushels of corn.

Opportunity cost of producing bushels of corn in U.S = 50/100 = 1/2 bushels of corn.

It implies that United states has lower opportunity cost in producing bushles of corn. Therefore, United has a specialisation in producing corn and export it. Similarly, Saudi Arabia has lower opportunity cost in producing barrels of oil . Therefore, Saudi arabia has specialisation in producing oil and export it.

Suppose that both countries devote some hours in the production of corn and some in production of oil, then production possibilities table is shown below, by devoting 60 hours in producing oil by saudi arabia and 40 hours in producing corn. Similarly, U.S devoted 40 hours in the production oil and 60 hours in the production of corn.

Country	Oil	Corn
Saudi arabia	60	10
U.S	20	60

Before trade , United states production and consumption of barrels of oil = 20 barrels. And corn = 60 bushels.

And for Saudi Arabia , Production and consumption of oil = 60 barrels and corn = 10 bushels.

If the U.S can trade an amount of corn fewer than 60 bushels and receives in exchange an amount of oil greater than 20 barrels , it will gain from trade. With trade, U.S can consume more of boh goods.

Similarly, if Saudi arabia can trade an amount of oil less than 60 barrels and receive in an exchange of amount corn greater than 10 bushels, it will gain from trade.