Question

The tables show combinations of two goods, steel and cloth, that can be produced in two nations ABC and RST.

In ABC

Steel

0

10

20

30

40

Cloth

100

75

50

25

0

In RST

Steel

0

20

40

60

Cloth

300

200

100

0

a. Using figures from the table plot each nation’s production possibility curves on the back. Label each of the curves.

b. Which nation has an absolute advantage in the production of cloth?_______ In steel? ______

c. Which nation has a comparative advantage in the production of cloth?______ In steel? ______

d. According to the Law of Comparative Advantage, nation _____ will export cloth and import steel. Nation _____ will export steel and import cloth.

Answer 1

A. The production possibility curve is defined as the combination of two goods that an economy produces given available resources and technology.


b. Country RST has absolute advantage in both commodities ( steel= 60 against 40 from ABC and cloth= 300 against 100 from ABC). Absolute advantage refers to the capacity and ability of any country to produce goods with lowest cost combination and with greater specialisation than any other country who produces the same goods. In this example, both countries produce steel and cloth but country RST produces more quantity of both goods with same resources and given technology.
c. Comparative advantage refers to the ability of a country to produce a good with low cost advantage relative to the other country producing the same good. Here in this example, country RST has comparative advantage in both and country ABC has comparative disadvantage in both. However, the nation RST has greater comparative advantage in production of cloth as it produces 300 units ( 3 times more than nation ABC which only produces 100 units of cloth.
Whereas the nation ABC has smaller comparative dis advantage in producing steel.
d. According to comparative advantage theory, nation RST will export cloth and import steel. Nation ABC will export steel and import cloth.