Suppose that: 1. Malaysia requires 1 hour of labor to produce 1 pound of rice an

Question

Suppose that:
1. Malaysia requires 1 hour of labor to produce 1 pound of rice and 2 hours of labor to produce 1 pencil;
2. Indonesia requires 2 hours of labor to produce 1 pound of rice and 4 hours of labor to produce 1 pencil;
3. each country has 10,000 hours of labor to allocate between the production of rice and pencils; and
4. in autarky, Malaysia consumes 5,000 pounds of rice and 2,500 pencils.
Which country has an absolute advantage in rice production? In pencil production?
Which country has a comparative advantage in rice production? In pencil production?
Will trade between the two countries be mutually beneficial?

Explanation / Answer

a) Absolute Advantage:

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.

Since, Malaysia is able to produce 1 pound of rice and 1 pencil in less number of hours as compared to Indonesia. This means Malaysia is able to produce more pounds of rice and pencils with same labor hours.

Malaysia has an absolute advantage in the production of rice and pencil both.

b) 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.

Malaysia: If country spend all its hours in production of one good.

10000 pounds of rice = 5000 pencils

1 pound of rice = 5000/10000 = 0.5 pencils

1 pencil = 10000/5000 = 2 pounds of rice

Opportunity cost of producing 1 pound of rice is 0.5 pencils and 1 pencil is 2 pounds of rice.

Indonesia:

5000 pound of rice = 2500 pencils

1 pound of rice = 2500/5000 = 0.5 pencil

1 pencil = 5000/2500 = 2 pound of rice

Opportunity cost of producing 1 pound of rice is 0.5 pencil and 1 pencil is 2 pound of rice.

Opportunity cost of producing 1 pound of rice and 1 pencil is equal in both countries so any country does not have any comparative advantage in one good.

No country has comparative advantage in the production of rice and pencils.

c) Because countries don't have comparative advantage in any good so trade between two countries will not be mutually beneficial.

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