Comparative Advantage
1.
a)
b)
c)
d)
e)
f)
g)
h)
In Canada, one ton of wheat requires 1/50 unit of resource and 1 microchip requires
1/20 unit of resource to produce. In Japan, one ton of wheat requires ½ unit of
resource and 1 microchip requires 1/12 unit of resource to produce. For simplicity, we
assume that these are the only two countries in the world.
Which country has an absolute advantage in the production of wheat? of microchips?
What is the opportunity cost of producing a ton of wheat in Canada? In Japan?
What country has a comparative advantage in the production of wheat? microchips?
Suppose Canada is endowed with two units of this all-purpose resource while Japan is
endowed with 10 units. Draw each country's production possibility curve in separate
diagrams with wheat on the vertical axis.
Suppose that prior to trade, each country allocated half of its resource endowments to
the production of each good. Indicate the production and consumption points of each
country on your diagrams.
What is world output of each good?
Indicate the production points of each country after trade
Suppose that the terms of trade are one microchip for one ton of wheat, and that
Canada consumes as much wheat after trade as it did before trade. Indicate the postconsumption points of each country, and each country's imports and exports.
2.
In France, 1 unit of clothing costs ½ unit of resource and 1 unit of food costs ½ unit of
resource. In Greenland, 1 unit of clothing costs 1 unit of resource and 1 unit of food
costs 3 units of resource. (Assume constant costs in both industries in both countries).
a) Starting from a situation in which each country is self-sufficient, if France increases
production of the commodity in which it has a comparative advantage by 50 units and
Greenland increases production of the commodity in which it has a comparative
advantage by 60 units:
i) By how much will world output of clothing change?
ii) By how much will world output of food change?
b) With free trade, what is the most that France could hope to get for each unit of its
exported product. Why?
What is the least France might receive for each unit of its exported product. Why?
c) If productivity in France and Greenland doubled in the production of both
commodities, would the answers to parts a) and b) change? Why do we get this result ?
3.
The following table specifies the number of units of labour required to produce in
Canada and in Brazil to produce 1 unit of raw materials (R) or 1 unit of manufactured
goods. Labour is the only factor of production; both industries in both countries are
constant-cost industries; and transportation costs are negligible.
UNITS OF LABOUR REQUIRED PER UNIT OF OUTPUT
Canada
Brazil
Raw Materials
.02
.05
Manufactured Goods
.01
.04
a) Determine the opportunity cost of each product for each country.
b) Which country has the comparative advantage in the production of each product?
c) Suppose Canada has 500 units of Labour and Brazil 100 units of Labour.
i) Graph each country's production possibilities curve.
ii) Plot on each graph the country's highest possible consumption possibility curve
attainable with international trade. (Label the axes for i) and ii) !)
d) Suppose that the international terms of trade are 2 units of raw material for 3 units of
manufactured goods. How much of each commodity will each country consume if after
trade, Brazil consumes 1000 units of raw materials?
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Comparative Advantage
4.
Argentina produces 10 pounds of beef or 4 pounds of bananas from one unit of
resource. Brazil produces 5 pounds of beef or 2 pounds of bananas from a similar unit
of resource. Therefore, Argentina
a) has an absolute and comparative advantage in beef
b) has an absolute and comparative advantage in bananas
c) has an absolute advantage in beef and a comparative advantage in bananas
d) has an absolute advantage in bananas and a comparative advantage in beef
e) has an absolute advantage in both commodities but a comparative advantage in
neither commodity.
Answers
1.a) Canada has an absolute advantage in both goods since Canada produces more of each
good with a unit of resource than does Japan.
b) Opportunity Cost of a ton of Wheat (W) in Canada is 0.4 Microchips (M) since 1/50
resource cost 1/50/1/20 = 0.4. Opportunity Cost of 1 ton of wheat in Japan is 1/2/1/12 =
Canada
Japan
6 Microchips.
W
W
c) Canada has the comparative
advantage in Wheat. Japan has
the comparative advantage in
100
M: 1 M cost 0.16 W compared
CPC
with 2.5 W in Canada.
CPC
d) (Japan's CPC doesn't meet the
PPC
PPC
20
W axis at 120 because Canada
can not produce 120W).
e) Canada produces and
100 M
40
120
consumes 50W and 20M.
Japan produces and consumes 10W and 60M.
f) World output is 60W and 80M.
g) Constant opportunity costs => total product specialization. Therefore, Canada
produces 100W and 0M and Japan 120M and 0W
h) Canada consumes 50W and 50M (exports 50W, imports 50M).
Japan consumes 50W and 70M (exports 50M, imports 50W).
(Canadian exports = Japanese imports in a two country world)
2. a)
First, establish opportunity costs.
France: 1 C cost 1/2/1/2 = 1F => 1F cost 1C
Greenland: 1C cost 1/3 = 1/3F and 1F cost 3C.
Second, establish comparative advantage for each country, ie, which country has the
lower O.C. for each commodity. France has comparative advantage in food (cost 1C
compared with 3C for Greenland) and Greenland has comparative advantage in
clothing (1/3F compared with 1F)
Now, in France, output of +50F => -50C
In Greenland, output of +60C => -20F
Therefore, i/ change in world output of C = +60 - 50 = +10C
ii/ change in world output of F = +50 - 20 = +30F
b/ France exports food in exchange for clothing from Greenland.
Each country will not accept terms of trade worse than their O.C
Greenland will not give France any more than 3C for 1F since they can produce 1F
with resources otherwise used to produce 3C
Similarly, France will not accept less than 1C for 1F.
c/ There is no change in either a/ or b/ because opportunity cost is still the same in each
country. (Each country's and world output of each commodity does change of course)
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M
Comparative Advantage
3.a) The opportunity cost in Canada of 1R is 0.02/0.01 = 2M or 1 M cost 0.5R
The opportunity cost in Braxil of 1R is 0.05/0.04 = 1.25M or 1M cost 0.8R
(We could also find this by noting that with one unit of labour:
Canada produces 1/.02 = 50 units of R or 1/.01 = 100 units of M
Brazil produces 1/.05 = 20 units of R or 1/.04 = 25 units of M.
Canada: O.C. of producing 50 R is 100 M => 1R cost 2M => 1M cost .5R
Brazil: O.C. of producing 20 R is 25M => 1R cost 1.25M => 1M cost .8R)
b) O.C. to produce 1M for Canada is .5R < .8R for Brazil
=> Canada has comparative advantage in Manufacture
O.C. to produce 1R for Canada is 2M > 1.25M for Brazil
=> Brazil has comparative advantage in Raw Materials
Canada
Brazil
c)
R
R
4000
2500
(2500, 2000)
2000
CPC
PPC
2500
4000 M
5000 M
Note that the two diagrams can’t coexist; Brazilian maximum CPC is at Canada’s
opportunity cost so that Canada’s CPC at this opportunity cost is Canada’s PPC.
Similarly, maximum CPC for Canada implies that Brazil’s CPC equals Brazil’s PPC.
d/ Brazil specializes in raw materiasl => Brazil produces 2000 R
Brazil consumes 1000R => Brazil trades 1000 R for 1500 M
Therefore, Brazil consumes 1000 R and 1500 M
Canada specializes in M => Canada produces 5000 M
Canada trades 1500 M for 1000 R from BrazilM
Therefore Canada consumes 1000 R and 3500 M (5000 - 1500)
4. e)
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