A Spanish can either produce 3 liters of win or 1 kilos of cheese. A Portuguese

Question

A Spanish can either produce 3 liters of win or 1 kilos of cheese. A Portuguese worker can either produce 4 litres of win or 12 kilos of cheese 1) Which countries have absolute advantages in which goods? Explain 2) Which countries have comparative advantages in which goods? Explain 3) Can the two countries gain from trade? If so then explain at what set of relative prices both countries gain from trade 4) Use an example to show how both countries can increase their consumption of both goods by trading with one another

Explanation / Answer

Table of production

Countries

Productions (suppose in 1 hour)

Liters of w

Kilos of c

Country S

3

1

Country P

4

12

1.

Absolute advantage: This is the comparison between two countries, of which one is producing goods more efficiently than other.

Country P has absolute advantage of producing both ‘w’ and ‘c’, since the volumes of production for both these products are higher than the country S.

2.

Comparative advantage: This is the comparison between the two countries, of which one country has lower opportunity cost than other.

Opportunity costs are given below:

Country S

1/3

3/1

Country P

12/4

4/12 = 1/3

Country S has the lowest ratio in ‘w’ and the country P has the lowest ratio in ‘c’. Therefore, S has the comparative advantage in producing ‘w’ and P has the comparative advantage of producing ‘c’.

Countries

Productions (suppose in 1 hour)

Liters of w

Kilos of c

Country S

3

1

Country P

4

12

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