2. (10 marks) The countries of East Wakovia and West Wakovia have the production

Question

2. (10 marks) The countries of East Wakovia and West Wakovia have the production possibilities tables for tobecco and corn shown below. Note that the costs of producing tobacco and corn are constant in both countries East Wakovia's Production Possibilitics Table Product Tobacco 20 16 12 16 West Wakovia's Production Possibilities Table Product Tobacco 15 12 (a) In East Wakovia, the opportunity cost of producing: 4 units of tobacco is 1 unit of tobacco is com units. Com units (b) In West Wakovia, the opportunity cost of producing 3 units of tobacco is 1 unit of tobacco is com units corn units (e) Which country has the comparative advantage in corn production and which country has the comparative advantage in tobacco production? (d) If each nation specializes in the product where it has a comparative advantage and trades with the other, what will be the limits to the terms of trade for each tobacco unit? (e) If East Wakovia is currently producing at combination D on its own PPC, and West Wakovia is at combination C on its own PPC, what would be gains from specialization and trade? (f) Assume the terms of trade is Itobacco 1.5 corn. Draw the production possibility curves (PPC) for East Wakovia and West Wakovia with and without an international trade

Explanation / Answer

Comparative cost advantage theory given by David Ricardo is the basis of international trade. This cost advantage theory says that countries should specialize in production of those goods in which country have greater comparative advantage and lesser comparative disadvanatge in comparison to other country.Comparative advantage and disadvantage of countries based on the opportunity cost.

Opportunity cost is the cost of second best alternative or it is the cost that country give up in production of one good.

Given, there are two countries, East Wakovia and West Wakovia producing two goods tobacco and corn with various alternatives of combination of two goods.

The below table shows the gains from trade and specialization.

The first table shows the production of before trade and the second table shows the production of after trade. So, country east wakovia have no gains from trade and country west wakovia is in gains from trade.Hence, there is a overall gain from trade and specialization.

Country Toabcco Corn Total Production East Wakovia 8 12 20 West Wakovia 9 10 19 World 17 22 39

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