Consider the production of two goods (wine and cloth) in two countries (England

Question

Consider the production of two goods (wine and cloth) in two countries (England and Portugal). The time requirements to produce one bottle of wine and one yard of cloth by workers in each country are given in the table: England Portugal 1 hour Time required to produce one bottle of wine Time required to produce one yard of cloth 4 hours 2 hours 1 hour 1. Which country has the absolute advantage in the production of wine? Which country has the absolute advantage in the production of cloth? Illustrate and explain. 2. Which country has the comparative advantage in the production of wine? Which country has the comparative advantage in the production of cloth? Illustrate and explain. 3. Which good or goods should England export to Portugal? Which good or goods should Portugal export to England? Explain. 4. In terms of the price of wine relative to the price of cloth, what range of prices will make both countries better off with specialization and trade? Illustrate and explain.

Explanation / Answer

1. Portugal has an absolute advantage in the production of wine as it requires less hours to produce one unit wine as compared to England. Here England requires more hours that is 4 hours to produce one unit of wine. In the production of cloth, Portugal has an absolute advantage as it requires only 1 hour to produce 1 yard of cloth whereas England requires more hours to produce 1 yard of cloth.

2. Portugal has a comparitive advantage in the production of wine. The reason for this is that the opportunity cost of wine in Portugal that is 1÷1= 1 is less than the opportunity cost of wine in England that is 4÷2= 2. England has a comapritive advantage in the production of cloth. In this case the opportunity cost of cloth in England is less that is 2÷4= 0.5 whereas the opportunity cost of cloth in Portugal is 1÷1= 1.

3. England will export cloth to Portugal as England has the comparitive advantage in the production of cloth. Portugal will export wine to England as Portugal had the comparitive advantage in the production of wine.

4. The price of wine in terms of cloth in Portugal is 1 and the price of wine in terms of cloth in England is 2.

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