Scenario 1 The United States can produce 20 planes. France can produce 12 planes

Question

Scenario 1

The United States can produce 20 planes.

France can produce 12 planes.

Scenario 2

Koreans can produce 3 cars or 9 motorcycles.

Germany can produce 4 cars or 8 Motorcycles.

Scenario 3

Japan can produce 4 laptops or 12 phones.

Brazil can produce 1 laptop or 5 phones.

Please answer the following questions:

With respect to scenario 1, which country has the absolute advantage?

With respect to scenarios 2 and 3, answer the questions below:

a. What is the opportunity cost of producing 1 unit of each product?

                              b. Who has comparative advantage?

c. What is the terms of trade that would benefit both countries

Explanation / Answer

(Question 1 - Scenario 1)

Since United States can produce more planes than France can (20 > 12), United States has absolute advantage in planes.

(Question 2 - Scenario 2)

(a) Opportunity cost (OC) are computed as follows.

In Korea,

OC of car = 9/3 = 3 motorcycles

OC of motorcycles = 9/3 = 0.33 car

In Germany,

OC of car = 8/4 = 2 motorcycles

OC of motorcycles = 4/8 = 0.5 car

(b)

Since Korea can produce motorcycles at a lower OC than Germany can (0.33 < 0.5), Korea has comparative advantage in motorcycles.

Since Germany can produce cars at a lower OC than Korea can (2 < 3), Germany has comparative advantage in cars.

(c)

Trade is mutually beneficial when terms of trade (TOT) lies between OC in both countries. So acceptable TOT are:

0.33 car < TOT of motorcycles < 0.5 car, or

2 motorcycle < TOT of car < 3 motorcycles.

(Question 3 - Scenario 3)

(a) Opportunity cost (OC) are computed as follows.

In Japan,

OC of laptop = 12/4 = 3 phones

OC of phones = 4/12 = 0.33 laptop

In Brazil,

OC of laptop = 5/1 = 5 phones

OC of phones = 1/5 = 0.2 laptop

(b)

Since Japan can produce laptops at a lower OC than Brazil can (3 < 5), Japan has comparative advantage in laptops.

Since Brazil can produce phones at a lower OC than Japan can (0.2 < 0.33), Brazil has comparative advantage in phones.

(c)

Trade is mutually beneficial when terms of trade (TOT) lies between OC in both countries. So acceptable TOT are:

2 Phones < TOT of laptops < 5 Phones or

0.2 Laptops < TOT of phones < 0.5 Laptops.

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