Chapter 20 The Theory Of Comparative Advantage
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20 The theory of comparative advantage
Chapter Twenty
The theory of comparative advantage
Self-assessment Questions 20.1
Country Rich has an absolute advantage in producing bread because it is more productive in bread than Country Poor, not because it is more productive in bread than machines.
20.2(a)
Yes, Japan possesses an absolute advantage in all goods if it is more productive in all of them.
20.2(b)
No. It is impossible for a country to possess a comparative advantage in all the goods it produces.
20.3
A country possesses a comparative advantage in a good over another country if its opportunity cost of producing that good is lower. The principle of comparative advantage states that if countries specialise in producing goods in which they have the lower opportunity cost, their combined output will be maximised.
20.4
If the terms of trade is 1 machine for 1.6 bread, then Country Rich’s gain from trade = (2 – 1.6) units of bread × 30 = 12 units of bread Country Poor’s gain from trade = (1.6 – 1.11) units of bread × 30 = 14.7 units of bread
Multiple Choice Questions 1 6
B C
2 7
C D
2
From the table, we find that
3
A
4
A
5
D
For Hong Kong, OC of 1 unit of garments = 0.33 unit of machines OC of 1 unit of machines = 3 units of garments For USA, OC of 1 unit of garments = 0.5 unit of machines OC of 1 unit of machines = 2 units of garments This shows that Hong Kong has a comparative advantage in producing garments. 3
At the terms of trade of 2.5 units of garments for 1 unit of machines, Hong Kong will get back 12 units of machines from exporting 30 units of garments. Its domestic opportunity cost of producing 30 units of garments is 10 units of machines. Hence, its gain from exporting 30 units of garments is 2 units of machines.
New Introductory Economics 3rd Edition 45 Suggested Solutions (2004 reprint with minor amendments)
© Pearson Education Asia Limited 2003
20 The theory of comparative advantage
4
From Q3, we know that its gain from exporting one unit of garments is 2/30 unit of machines = 0.067 unit of machines. If the transport cost per unit of garments exceeds 0.067 units of machines, Hong Kong cannot gain from trade, and hence will not trade with USA.
5
From the table, we find that the production possibilities of Country A and Country B are Wheat Country A
600
Country B
Wool 400
OR 800
200
Country B possesses a comparative advantage in producing wheat because its opportunity cost of wheat (0.25 unit of wool) is lower than that of Country B (0.67 unit of wool). 6
If Country A and Country B specialise completely according to the principle of comparative advantage, their combined output will be 800 units of wheat and 400 units of wool, i.e. 100 units more of each.
Short Question 8(a) 8(b)(i)
Good Y, because it enjoys a comparative advantage in producing it. Country A’s gain from trade: Domestic opportunity cost: 1X: 2Y Terms of trade: 1X:1.5Y By importing 10 units of X, Country A exports 15 units of Y. Its domestic opportunity cost of producing 15 units of Y is 7.5 units of X. Hence, it gains 2.5 units of X.
8(b)(ii)
By importing 10 units of X, Country A exports 15 units of Y. If it has to produce the 10 units of X herself, it has to sacrifice 20 units of Y. Therefore, it saves 5 units of Y.
Structured Essay Question 9(a)
In Country A, the cost of producing 1 unit of machines is 0.67 unit of bread.
9(b)(i)
Country A possesses an absolute advantage in producing bread because with one unit of resources, it can produce more bread than Country B.
9(b)(ii)
Country A has a comparative advantage in producing bread because its opportunity cost of producing bread (1.5 units of machines) is lower than that of Country B (4 units of machines).
9(c)(i)
Country A will export bread. It gains because its export price exceeds its domestic opportunity cost. Its gain = (2 – 1.5) × 100 units of machines = 50 units of machines
New Introductory Economics 3rd Edition 46 Suggested Solutions (2004 reprint with minor amendments)
© Pearson Education Asia Limited 2003
20 The theory of comparative advantage
9(c)(ii)
Country B will export machines. It gains because its export price exceeds its domestic opportunity cost. Its gain = (0.5 – 0.25) × 60 units of bread = 15 units of bread
9(d)
Two reasons are: 1)
If transport cost is prohibitively high, countries may not engage in trade.
2)
If insurance cost is prohibitively high due to high risks, countries may also choose not to trade.
New Introductory Economics 3rd Edition 47 Suggested Solutions (2004 reprint with minor amendments)
© Pearson Education Asia Limited 2003
Chapter Twenty
The theory of comparative advantage
Self-assessment Questions 20.1
Country Rich has an absolute advantage in producing bread because it is more productive in bread than Country Poor, not because it is more productive in bread than machines.
20.2(a)
Yes, Japan possesses an absolute advantage in all goods if it is more productive in all of them.
20.2(b)
No. It is impossible for a country to possess a comparative advantage in all the goods it produces.
20.3
A country possesses a comparative advantage in a good over another country if its opportunity cost of producing that good is lower. The principle of comparative advantage states that if countries specialise in producing goods in which they have the lower opportunity cost, their combined output will be maximised.
20.4
If the terms of trade is 1 machine for 1.6 bread, then Country Rich’s gain from trade = (2 – 1.6) units of bread × 30 = 12 units of bread Country Poor’s gain from trade = (1.6 – 1.11) units of bread × 30 = 14.7 units of bread
Multiple Choice Questions 1 6
B C
2 7
C D
2
From the table, we find that
3
A
4
A
5
D
For Hong Kong, OC of 1 unit of garments = 0.33 unit of machines OC of 1 unit of machines = 3 units of garments For USA, OC of 1 unit of garments = 0.5 unit of machines OC of 1 unit of machines = 2 units of garments This shows that Hong Kong has a comparative advantage in producing garments. 3
At the terms of trade of 2.5 units of garments for 1 unit of machines, Hong Kong will get back 12 units of machines from exporting 30 units of garments. Its domestic opportunity cost of producing 30 units of garments is 10 units of machines. Hence, its gain from exporting 30 units of garments is 2 units of machines.
New Introductory Economics 3rd Edition 45 Suggested Solutions (2004 reprint with minor amendments)
© Pearson Education Asia Limited 2003
20 The theory of comparative advantage
4
From Q3, we know that its gain from exporting one unit of garments is 2/30 unit of machines = 0.067 unit of machines. If the transport cost per unit of garments exceeds 0.067 units of machines, Hong Kong cannot gain from trade, and hence will not trade with USA.
5
From the table, we find that the production possibilities of Country A and Country B are Wheat Country A
600
Country B
Wool 400
OR 800
200
Country B possesses a comparative advantage in producing wheat because its opportunity cost of wheat (0.25 unit of wool) is lower than that of Country B (0.67 unit of wool). 6
If Country A and Country B specialise completely according to the principle of comparative advantage, their combined output will be 800 units of wheat and 400 units of wool, i.e. 100 units more of each.
Short Question 8(a) 8(b)(i)
Good Y, because it enjoys a comparative advantage in producing it. Country A’s gain from trade: Domestic opportunity cost: 1X: 2Y Terms of trade: 1X:1.5Y By importing 10 units of X, Country A exports 15 units of Y. Its domestic opportunity cost of producing 15 units of Y is 7.5 units of X. Hence, it gains 2.5 units of X.
8(b)(ii)
By importing 10 units of X, Country A exports 15 units of Y. If it has to produce the 10 units of X herself, it has to sacrifice 20 units of Y. Therefore, it saves 5 units of Y.
Structured Essay Question 9(a)
In Country A, the cost of producing 1 unit of machines is 0.67 unit of bread.
9(b)(i)
Country A possesses an absolute advantage in producing bread because with one unit of resources, it can produce more bread than Country B.
9(b)(ii)
Country A has a comparative advantage in producing bread because its opportunity cost of producing bread (1.5 units of machines) is lower than that of Country B (4 units of machines).
9(c)(i)
Country A will export bread. It gains because its export price exceeds its domestic opportunity cost. Its gain = (2 – 1.5) × 100 units of machines = 50 units of machines
New Introductory Economics 3rd Edition 46 Suggested Solutions (2004 reprint with minor amendments)
© Pearson Education Asia Limited 2003
20 The theory of comparative advantage
9(c)(ii)
Country B will export machines. It gains because its export price exceeds its domestic opportunity cost. Its gain = (0.5 – 0.25) × 60 units of bread = 15 units of bread
9(d)
Two reasons are: 1)
If transport cost is prohibitively high, countries may not engage in trade.
2)
If insurance cost is prohibitively high due to high risks, countries may also choose not to trade.
New Introductory Economics 3rd Edition 47 Suggested Solutions (2004 reprint with minor amendments)
© Pearson Education Asia Limited 2003
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