Consider a world with two countries, Home and Foreign, and two goods, good X and
ID: 1132420 • Letter: C
Question
Consider a world with two countries, Home and Foreign, and two goods, good X and good Y. Both countries use labor as the only factor of production. Both countries are endowed with 100 workers. [Please make sure that you add labels on figures you draw: vertical axis, horizontal axis, PPF, indifference curves, equilibrium points, etc.]
1) Which good(s) does Home have absolute advantage in? Which good(s) does Home have comparative advantage in?
Good X
Good Y
Home
MPL = 2
MPL = 1
Foreign
MPL = 6
MPL = 2
Good X
Good Y
Home
MPL = 2
MPL = 1
Foreign
MPL = 6
MPL = 2
Explanation / Answer
Answer : 1) Given, Labour endowment = 100
According to question, MPL = 2 for good X in Home country. This means that the total production of good X is (100 × 2) =200 units in Home country by using 100 labour endowment.
Again, MPL = 1 for good Y in Home country. This means that the total production of good Y is (100 × 1) = 100 units in Home country by using 100 labour endowment.
As by using 100 labour endowment Home country gets more production for good X, hence the Home country has absolute advantage in producing good X.
Now, if Home country produce good X = 200 units then the country loose good Y = 100 units. This means here the production of
200 units of good X looses the 100 units of good Y
1 unit of good X loose = 100/200 = 0.5 unit of good Y.
Therefore, the opportunity cost of producing 1 unit of good X is 0.5 unit of good Y.
Again, production of
100 units of good Y looses 200 units of good X.
1 unit of good Y loose = (200/100) = 2 units of good X.
Therefore, here the opportunity cost of producing 1 unit of good Y is 2 units of good X.
As the Home country gets lower opportunity cost in producing good X, hence the Home country has comparative advantage in producing good X.