6. FIGURE 1 (20 POINTS) 8 12 10 10 8 E 6 E 6 6 2 6 4 6 Wine (million barrels) (a

Question

6. FIGURE 1 (20 POINTS) 8 12 10 10 8 E 6 E 6 6 2 6 4 6 Wine (million barrels) (a) England Wine (million barrels) (b) Portugal Figure 1 above shows the number of yards of cloth and barrels of wine that can produced with a year's worth of labor in England and Portugal. Assume that no other inputs are needed. . If there is no trade, what is the price of wine in terms of cloth in England? f there is no trade, what is the price of wine in terms of cloth in Portugal? . Which country has an absolute advantage in the production of which good(s)? Which country has a comparative advantage in the production of which good(s Explain how the country achieved the absolute and comparative advantage(s)

Explanation / Answer

A) England:

2 million barrels of wine = 8 million yards of cloth

1 barrel of wine = 8million/2million = 4 yards of cloth

Portugal:

6 million barrels of wine = 12 million yards of cloth

1 barrel of wine = 12 million/6million = 2 yards of cloth

B) Absolute advantage is the ability of a country to produce a good or service at a lower per unit cost as compared to any other country that produces same good or service.

Portugal has an absolute advantage in producing both goods.

A country has a comparative advantage in producing that good if the opportunity cost of producing that good is lower in that country as compared to another country.

England:

2 million barrels of wine = 8 million yards of cloth

1 barrel of wine = 8million/2million = 4 yards of cloth

1 yard of cloth = 2million/8million = 0.25 barrel of wine

Portugal:

6 million barrels of wine = 12 million yards of cloth

1 barrel of wine = 12 million/6million = 2 yards of cloth

1 yard of cloth = 6million/12 million = 0.5 barrel of wine

Opportunity cost of producing 1 barrel of wine is less when it is produced by Portugal. Portugal has comparative advantage in the production of wine. Opportunity cost of producing 1 yard of cloth is less when it is produced by England. England has comparative advantage in the production of cloth.

C) Portugal is specialized in production of wine so produce only wine i.e. 6 million barrels

England is specialized in production of cloth so produce only cloth i.e. 8 million yards.

England will export cloth and import wine. Portugal will export wine and import cloth.

D) Both country will be better off with trade than they are without trade. When they produce goods in which they have comparative advantage then England will produce 8 million yards of cloth and Portugal will produce 6 million barrels of wine.

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