The United States and Russia each produce only bearskin caps and wheat. Domestic

Question

The United States and Russia each produce only bearskin caps and wheat. Domestic prices are given in the following table.
Russia US
Bearskin caps 10Ru $7
Wheat 15Ru $10

Exchange rate is $1 = 1Ru.
a. Which country has an absolute advantage in production of caps? In wheat?
b. Which country has a comparative advantage in production of caps? In wheat?
c. If the US and Russia were the only two countries engaging in trade, what adjustments would you predict, assuming exchange rates are freely determined by the laws of supply and demand.

Explanation / Answer

Absolute advantage refers to the advantage a country has in an activity if they can do it better than others. So which country is more efficient in the wheat and cap business? comparative advantage is the advantage a country has in producing a good or service if the opportunity cost of producing the good or service is lower for that country than for others. Keep in mind Opportunity cost refers to the real cost of an item so which ever country spends the least money making their products has the comparative advantage

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