Specialization in Trade

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Specialization in Trade

1. a) A country is said to have an absolute advantage in the production of a good if it can produce it using fewer resources than another country. On the other hand, a country is said to have a comparative advantage in the production of a good if it can produce the good at a lower opportunity cost than another country b) The theory of comparative advantage suggests that even though one country is “better” at producing both goods (concerning two countries), these countries should still trade having in mind the opportunity costs (how much they have to give up of the other good). The theory of absolute advantage determines that a country that has an absolute advantage produces a greater output of goods and services than other countries, while using the same amount of resources. c) The theory of comparative advantage is a more powerful explanation of the benefits from trade because it explains how even though one country might have an absolute advantage in the production of two goods (of both countries), the other country is still able to trade and be “better-off” than in the beginning (having in mind the opportunity costs). However, this theory is based on several assumptions which limit the application of the theory in real-life (such as that there are transport costs, there isn't perfect knowledge of the market, there aren't only two economies producing two goods...).

3. a)

b) Lakeland and Mountainland can gain from specialization and trade because since they are both producing the good with their lowest opportunity cost, they produce the maximum level of output by effectively allocating their resources. By specializing, the country can consume some of the product and then export any extra, resulting in higher revenues which they can then use to import other goods.

c) (done)
5. a) Country A has the absolute advantage of producing good Y while country B has the absolute advantage of producing good X. c) Yes, country B has the absolute advantage of producing both good X and good Y.

7.
Production possibilities for country A and country B

Good X
Opportunity Cost
(good X)
Good Y
Opportunity Cost (good Y)
Country A
8
0.25
2
4
Country B
2
2
4
0.5
* Country A: Has a comparative advantage in the production of good X. Therefore, it should specialize in the production of good X, export it, and import good Y. Country B: Has a comparative advantage in the production of good Y. Therefore, it should specialize in the production of good Y and export it while importing good X. PPC diagram

Production possibilities for country A and country B

Good X
Opportunity Cost
(good X)
Good Y
Opportunity Cost (good Y)
Country A
8
0.75
6
1,33
Country B
2
2
4
0.5
* Country A: Has a comparative advantage in the production of good X. Therefore, it should specialize in the production of good X, export it, and import good Y. Country B: Has a comparative advantage in the production of good Y. Therefore, it should specialize in the production of good Y and export it while importing good X. PPC diagram

Production possibilities for country A and country B

Good X
Opportunity Cost
(good X)
Good Y
Opportunity Cost (good Y)
Country A
1
2
2
0.5
Country B
4
0.5
2
2

* Country A: Has a comparative advantage in the production of good Y. Therefore it should specialize in the production of good Y and export it while importing good X. Country B: Has a comparative advantage in the production of good X. Therefore, it should specialize in the production of good X and export it while importing good Y.

PPC diagram

Production possibilities for country A and country B

Good X
Opportunity Cost
(good X)
Good Y
Opportunity Cost (good Y)
Country A
6
0.5
3
2
Country B
3
0,33
1
3

* Country A: Has a comparative advantage in the production of good X. Therefore, it should specialize in the...
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