Suppose there are two countries, Germany and India, and two goods, bicycles and

Question

Suppose there are two countries, Germany and India, and two goods, bicycles and textiles. Germany has a resource endowment of 42,444,325 units of labor and 8,873,941 million units of capital, while India has a resource endowment of 475,090,729 units of labor and 10,299,894 million units of capital. Each bicycle requires 100 units of capital and 10 units of labor to produce, and each unit of textiles requires 40 units of capital and 2 units of labor to produce.

b. Which country is capital abundant and which is labor abundant?

Explanation / Answer

Absolute advantage is the ability to produce one good at lower cost per unit than the other country who is also producing same good at higher cost per unit.

Thus a country requires smaller quantity of input to produce a good is to have an absolute advantage.

Germany produce 10 auto/labour hour but Canada produces 5 autos/labour hour. On the other hand in one labour hour Germany makes 50 sofas and Canada makes 40 sofas. Therefore Germany has absolute advantage in making both auto and sofa.

Now in trade who produces what depends on comperative advantage. This is closely related with opportunity cost of producing one goods with respect to other goods. The country produces and trades only low opportunit cost product.

Germany has comperative advantageon auto and Canada has comperative advantage on sofa. Therefore Germany only produces sofa with its endowment of labour. Therefore total auto production is 5000 auto. On the other hand Canada only produces and exports sofa with its total labour endowment. hence total sofa production is 4000.

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