Question

1A.  Assume a two-nation world consisting of Nations East and West.  Assume both nations are using their resources to the best of their abilities and that the tables below for each nation show the various combinations of Food and Clothing each can produce.  Assume that Nation East currently is specializing in the production of Food and is producing at combination A.  West, choosing to be self-sufficient, is producing at combination C.  East has chosen to produce at combination A because it produces Food twice as efficiently as Clothing and East hopes that by doing so it can improve its lot by making Food and trading with West for needed  Clothing.

East Production Possibilities:

Product                                    A          B          C          D

Food                                        24        16        8            0

Clothing                                     0          4        8          12

West Production Possibilities:

Product                                    A          B          C          D

Food                                        45        30        15        0

Clothing                                     0          5        10        15

a. Given that West produces either Food or Clothing more efficiently than East, would it make any sense for West even to consider trading with East?

b. Although East produces Food more efficiently than Clothing, has its decision to specialize in the production of Food been a wise choice?  Explain.

c. Suppose that East and West decide to explore together the possible benefits of specialization and trade.  Which product would you advise each to produce?  Why?

d. If they do specialize and trade, how much more food and clothing might they have to share (gains from trade) compared to what they together produce now?  (You need to come up with numbers here.)

Answer 1

a) West has an advantage of producing both Food and Clothing when compared to the East. However, the West has a comparative advantage in producing Food than Clothing. The theory of competitive advantage suggests that the country of firm should use its resources in producing the goods in which they have comparative advantage and then it should trade with other countries. The West should consider the trade with the East which will beneficial for both the countries.

b) The East is producing Food more efficiently. However, the West has comparative advantage over the East in producing the Food. In such scenario, the West should use its specialization in producing Food and it means the East should specialize in producing Clothing. That will be the better for overall welfare.

c) The comparative advantage in producing a good actually encourages specialization and trade. The countries having comparative advantage should focus on the product in which they are better and use all the resources for producing it.
In the above scenario, the West has a comparative advantage in producing Food so it should focus on producing Food only. On the other hand, the East should focus only on Clothing. This will mean more production of goods for consumption and cheaper price.

d) Earlier the East was producing at point A and that means 24 units of Food.
The West was producing point C which is 15 units of Food and 10 units of Clothing.

Total Production
Food = 24 + 15 = 39 units
Clothing = 10 units

After specialization, the East will produce 12 units of Clothing while the West will produce 45 units of Food.
Total Production
Food = 45 units
Clothing = 12 units

Gains form specialization,
Food : 45 - 39 = 6 units
Clothing : 12 -10 = 2 units