Question

1. Iceland and Denmark both produce skis and sleds. Iceland can produce 3 skis or 6 sleds using one day of labor, while Denmark can produce 4 skis or 12 sleds using one day of labor. [ 6 POINTS]

1. Which country has an absolute advantage in producing skis? Sleds?
2. Which country has a comparative advantage in producing skis? Sleds?
3. Are gains from trade possible between Iceland and Denmark? If yes, which good should each country specialize in producing?

Answer 1

A) The country which can produce a good more than other country with same resources will have an absolute advantage in production of that good.

Here Denmark is producing both skis and sleds than Iceland,hence Denmark have an absolute advantage in production of both the goods.

b) The country which can produce a good at low opportunity cost than other country will have an comparative advantage in production of good.

Country	Skis	Opportunity cost in term of Sleds	Sleds	Opportunity cost in terms of skis
		3 Skis = 6 Sleds		6 Sleds = 3 Skis
Iceland	3	1 ski = 2 sleds	6	1 sled = 0.5 ski
		4 skis = 12 sleds		12 sleds = 4 skis
Denmark	4	1 ski = 3 sleds	12	1 sled = (1/3) ski

Here Iceland can produce ski at a lower opportunity cost than Denmark where Denmark can produce Sleds at a lower opportunity cost than Iceland.

3) Yes gains from trade is possible when a country has comparative advantage in production of goods. Country which have a comparative advantage in production of a particular good should specialize in it in production.

Hence Iceland should specialize in ski and Denmark in Sled.