Home Page EC 340, International Trade and Finance Files EC 340 Problem Sets Comparative Advantage Answers

|  Search

Answers to Problem Set #1

U.S.: 30/20 = 1.5
R.O.W.: 100/60 = 1.67
So, the rest of the world is labor abundant. That means the U.S. must be capital abundant.

2. a. If France produces only champagne it can produce 50 bottles while Mexico would be able to produce 10. Since the country that is able to produce a good using fewer resources has the absolute advantage in producing that good, France has the absolute advantage in champagne production.

b. If both countries produce only Kahlua, France produces 25 bottles while Mexico produces 10 bottles. France has the absolute advantage in Kahlua production.

c. Comparative advantage exists when a country is able to produce a good at a lower opportunity cost compared to another country. Opportunity cost is equal to the amount gave up divided by the amount gained. Start with both countries producing no champagne and then move up one row of the PPC. For Mexico, they produce 2 bottles of champagne but Kahlua production falls by 2. So, their opportunity cost of champagne is 1. For France, they produce 10 bottles of champagne while Kahlua production drop s from 25 to 20. France's opportunity cost is 1/2. So, France has the comparative advantage in champagne.

d. A country cannot have a comparative advantage in both goods, so Mexico must have the comparative advantage in Kahlua production.

3. The gain in consumers surplus is equal to the area under the demand curve between the original price of $2 and the world price of $1: ($1)(6)+(1/2)(2)($1) = $7. The fall in producers surplus is the area above the supply curve between the two prices: ($1)(3)+(1/2)(3)($1) = $4.50. The rise in net national welfare is equal to $7 - $4.50 = $2.50.

4. See the notes for lecture 1.

David A. Latzko 318 COB Department of Business and Economics Wilkes University Wilkes-Barre, PA 18766 phone: (717) 408-4718 fax: (717) 408-4917 dlatzko@wilkes.edu wilkes1.wilkes.edu/~dlatzko