International Economics I
ANSWERS 1
Research Assistant Aslı Özgür AKTAY FİDAN 1
1. In Case A, for example, it is seen that one hour of labor time produces 4 bushels of
wheat in the US while the same amount of labor time produces 1 bushel of wheat in
the UK. That is, the US is more efficient than (has an absolute advantage over) the UK
in the production of wheat. In terms of cloth production, the UK has an absolute
advantage over the US because one hour of labor time produces 1 yard of cloth in the
US but 2 yards of cloth in the UK. Following the same procedure, it can be concluded
that the US has absolute advantage over the UK in production of wheat in all cases.
The US has also absolute advantage in production of cloth in cases B and D. In case C,
neither of the countries has advantage or disadvantage in production of cloth.
2. If a nation has an absolute advantage respect to other nation in both goods, there is still
a basis for mutually beneficial trade. The nations should specialize in production of
the good that it has greater absolute advantage (export it) and they should import the
good that they have a smaller absolute advantage.
Greater absolute advantage  comparative advantage
Smaller absolute advantage  comparative disadvantage
Case A: Law of absolute advantage holds, so does comparative advantage. The US
exports wheat whereas the UK exports cloth.
Case B: The US is 4 times more productive in wheat with respect to the UK. However,
it is only 1,5 times more productive than the UK in production of cloth. In other
words, the UK is 4 times less productive in wheat and only 1,5 times less productive
in cloth. That is, the US absolute advantage is greater in wheat (4:1) so its comparative
advantage lies in wheat. The UK absolute disadvantage is smaller in cloth (3:2) so its
comparative advantage lies in cloth. It is then expected for the US to specialize in
1
Yıldız Technical University, Faculty of Economics and Administrative Sciences, Department of Economics,
Istanbul/ TR
wheat production and export it to the UK in Exchange for cloth while the UK
specializes in cloth production and export it to the US in Exchange for wheat.
Case C: The US is 4 times more productive in wheat with respect to the UK. In case
of cloth production, neither of the countries has absolute advantage over one
another. Therefore, the UK is expected to prefer to specialize in an industry where it
has no disadvantage (or advantage for that matter) rather than the industry where it is 4
times less productive. So just like Case B, the US exports wheat in exchange for cloth
to the UK and the UK exports cloth in exchange for wheat.
Case D: The case of no comparative advantage: This situation occurs when absolute
advantage/disadvantage of one country over the other remains same for both
commodities. UK is indefferent about the exchange of 2 bushels of wheat for 1 yard of
cloth, i.e 4 bushels of wheat for 2 yards of cloth: The same production possibilities
rate as the US has. That is why neither of them have comparative advantage so no
mutually beneficial trade can take place.

“Even if one nation has an absolute disadvantage with respect to the other
nation in the production of both commodities, there is stil a basis for mutually
beneficial trade, unless the absolute disadvantage that one nation has with
respect to the other nation is in the same proportion for the two
commodities.” (Salvatore 2013, p.39)
3. Please see the answer 2.
4. US  4W  UK
US  4C  UK
a) US’s gain in terms of cloth: The US is indifferent for an exchange of 4W for 3C
according to Case B. Therefore, it is expected to be eager for a trade where it receives
more than 3C. In this case, the US exports 4W in exchange for 4C, that is it gains 1C
in terms of cloth. (In terms of labor: 1C is 1/3 labor time in the US so it gains 1/3
hours of labor.)
b) UK’s gain in terms of cloth: The UK is indifferent for an exchange of 4W for 8C
according to Case B. (The proportion of the production possibilities for two goods is
1:2) Therefore, The UK is willing to trade (export) no more than 8C if it is to import
4W. In this case, it exports 4C in exchange for 4W. That is, it gains 4C in terms of
cloth.  For a better understanding, it can be considered that if UK gives up
producing wheat, with the same production possiblities now only used for
production of cloth, it can produce twice as much it were to produce wheat. That
is, if UK gives up production of 4W(because it imports it), it can devote all its
production possibilities (labor, technology etc) to cloth production and in this
case it can produce 8C. So UK wouldn’t prefer to export 8C or more in exchange
for 4W because it wouldn’t be profitable. Here, when it exports 4C, it means the
UK spares production possibilities enough for production of 4C (8C-4C=4C),
thus its gain is 4C. (In terms of labor: 2 hours of labor work is used for production of
4C in the UK so the UK gains 2 hours of labor.)
c) Rate for mutually beneficial trade: Since the US wants to import more than 3C and the
UK wants to export less than 8C in exchange for 4W, the range will be:
3C  4W  8C
d) US  4W  UK
US  6C  UK
In this case, following the same steps of the previous questions, the US appears to gain
3C while the UK gains 2C. (In terms of labor: US and UK gain 1 hour of labor work
each.)
5.
a)
US
UK
1 bushel of wheat
1/4
1
1 yard of cloth
1/3
1/2
This is the table for how much labor is needed for 1 unit of the each commodity in
each country. For example in the US, 1 hour of labor work produces 4 bushels of
wheat, i.e in order to produce 1 bushel of wheat, 1/4 hour of labor is needed.
b) Wage rate in the US is $6.
Price of wheat: Pw = 1/4 x 6 = $1,5 (price of 1 unit of wheat)
Price of cloth: Pc = 1/3 x 6 = $2
Hidden assumptions here are that there is no other factor then wage rate for
determination of the price and that the wage rate is same for both of the sectors.
c) Wage rate in the UK is £1.
Price of wheat: Pw = 1 x 1 = £1
Price of cloth: Pc = 1/2 x 1 = £0,5
6. With reference to problem 5:
a) Exchange rate (R): £1 = $2
In order to find the basis of trade (if it is possible) we compare the costs the countries
face when they produce these two commodities. In this case, we compare the prices of
the commodities in each country in terms of dollar and conclude that the countries are
expected to export the goods that they manage to produce at a lower price rate. Price
here also gives a clue about the wage rates, i.e costs.
Lower price of one good also means that business people or traders would want to buy
the good with a lower price in one country and sell it to the other country with a higher
price when converted to the same currency. Prices for wheat and cloth:
US
UK
in terms of dollar: US
UK
Pw
$1,5 £1
$1,5
$2
Pc
$2
$2
$1
£0,5
The price of wheat is lower in the US whereas the price of cloth is lower in the UK. In
this case, the US is able to export wheat to the UK and the UK is able to export cloth
to the US. The inefficiency of UK labor(absolute disadvantage of the UK in cloth
according to Case B) relative to US labor in cloth production is more than
compensated by lower wages in the UK.
b) R: £1 = $4
US
UK
Pw
$1,5 $4
Pc
$2
$2
 In this case, the only trade would be the export of wheat
from the US to the UK. They are indifferent about the cloth trade, so mutually
beneficial trade cannot take place. Only one-sided trade is an unbalanced trade. The
dollar price of the pound is expected to fall (dollar is expected to appreciate) in this
case, making the trade balanced (2-sided) at a certain Exchange rate.
c) R: £1 = $1
US
UK
Pw
$1,5 $1
Pc
$2
$0,5
 All the export is done by the UK. Another example of
unbalanced trade. In this case, the dollar price of the pound is expected tor ise until it
becomes a balanced trade where both actors can export.
d) The range for exchange rate which enables a mutually beneficial trade: The exchange
rate in question b is one side of the range where the UK stops to sell cloth to the US. If
we consider a situation when dollar price of the pound is a bit less than 4 dollars, say
3,8; then the Pc in the UK would be $1,9 which enables UK to export cloth. Fort he
other side of the range, we consider where the US would stop to export wheat. That is,
the wheat prices would be same for each country. We can reach to that situation if the
Exchange rate is considered to be £1 = $1,5. So range should be:
$1,5  £1  $4