There are two ways to compare the ability of two people or two countries to produce...

There are two ways to compare the ability of two people or two countries to produce a good: an absolute advantage and a comparative advantage. Which one is the gains from trade are based on? Why? Provide a numerical example illustrating the difference between the two.

Expert Solution

Answer: comparative advantage indicates gains from trade.

Example:

Table of production

Countries	Productions (suppose in 1 hour)
Countries	Banana	Car
Country TV	40	35
Country TS	20	30

Absolute advantage: This is the most efficient way of production between the two countries or people.

Country TV has absolute advantage of producing both banana and car, since the amounts of production for both these products are higher than the country TS.

As per the absolute advantage, country TV specializes both for banana and car.

Comparative advantage: This is the production at lower opportunity cost between the two countries or people.

Opportunity costs (OC) are given below:

Country TV	35/40 = 7/8	40/35 = 8/7
Country TS	30/20 = 3/2	20/30 = 2/3

Country TV has the lowest ratio in banana and the country TS has the lowest ratio in car. Therefore, TV has the comparative advantage in producing banana and TS has the comparative advantage of producing car.

As per the comparative advantage, country TV specializes in banana and country TS specializes in car.

Terms of trade:

The country having comparative advantage should export the good to other country. Therefore, TV should export banana and TS should export car. In this way, both the countries gain.

Required term: 1 unit of banana is between 7/8 car and 3/2 car. (By looking at the OC column of banana)

Required term: 1 unit of car is between 8/7 banana and 2/3 banana. (By looking at the OC column of car)

Rahul Sunny answered 1 year ago

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There are two ways to compare the ability of two people or two countries to produce...

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