A. Assume countries can produce two goods, X and Y. Country A can produce 5 X if

Question

A. Assume countries can produce two goods, X and Y. Country A can produce 5 X if it uses all of its resources for X production or 5 Y if it uses all resources for Y production. Country B can either produce 12 X or 2 Y with its resources. Illustrate and evaluate the potential of these countries to trade. What about when Country B invents a new machine that can increase its maximum amount of Y production to 6?

B. Given Part A, should these countries adopt free trade policies with each other? Explain.

Explanation / Answer

Countries trade on the basis of comparative advantage (lower opportunity costs)

Country A:

Opportunity cost of producing 1 unit of X = 5/5 = 1 unit of Y

Country B:

Opportunity cost of producing 1 unit of X = 2/12 = 1/6 unit of Y

(Country B should specialize in production of X/export X while Country A should specialize in production of Y/export Y)

New opportunity cost of country B for 1 unit of X = 6/12 = 1/2 units of Y (the difference in the opportunity costs remains for a mutually beneficial trade)

B)

Countries A and B should adopt free trade policies as there is a difference between their opportunity costs of production and therefore basis for mutually beneficial trade.

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.