Chapter 20, Problem 2P

To determine

The comparative advantage of countries.

Answer to Problem 2P

Option (a): New Zealand- The cost of producing 1 Apple is 0.25 plums and the cost of producing 1 plum is 4 Apples.

Spain- The cost of producing 1 Apple is 1 plum and the cost of producing 1 plum is 1 Apple.

Option (b): New Zealand should produce apples and Spain should produce plums.

Option (c): Graph

Option (d): The total gain of Apples is 20 and the total gain of plums is 10.

Explanation of Solution

The comparative advantage is the advantage that the country has over the competitor in the opportunity cost of producing the commodity. The resources of production can be used for the purpose of the production for other alternatives. Thus, the cost of the next best alternative that we have foregone is the opportunity cost of production. The opportunity cost of the production is the main reason behind the comparative advantage of the country. When the opportunity cost of production is lower in the country, then it can focus on the production of that commodity which can increase its total output.

Option (a):

In New Zealand, the production of 20 apples needs the resources which can alternatively be used for the production of 5 plums. Thus, the opportunity cost of producing 1 apple can be calculated by dividing the total units of plums given up by the total units of apples gained as follows:

$\begin{array}{c}{\text{Opportunity cost of Apple}}_{\text{New Zealand}}=\frac{\text{Units of Plums given up}}{\text{Units of Apple gained}}\\ =\frac{5}{20}\\ =0.25\end{array}$

Thus, the opportunity cost of producing 1 apple in New Zealand is 0.25 plums.

The opportunity cost of producing plum in New Zealand can be calculated by dividing the number of units of apples given up with the number of units of plums gained as follows:

$\begin{array}{c}{\text{Opportunity cost of Plum}}_{\text{New Zealand}}=\frac{\text{Units of Apples given up}}{\text{Units of Plums gained}}\\ =\frac{20}{5}\\ =4\end{array}$

So, the opportunity cost of producing 1 plum in New Zealand is 4 apples.

In Spain, the production of 20 apples needs the resources which can alternatively be used for the production of 20 plums. Thus, the opportunity cost of producing 1 apple can be calculated by dividing the total units of plums given up by the total units of apples gained as follows:

$\begin{array}{c}{\text{Opportunity cost of Apple}}_{\text{Spain}}=\frac{\text{Units of Plums given up}}{\text{Units of Apple gained}}\\ =\frac{20}{20}\\ =1\end{array}$

Thus, the opportunity cost of producing 1 apple in Spain is 1 plum.

The opportunity cost of producing plum in Spain can be calculated by dividing the number of units of apples given up with the number of units of plums gained as follows:

$\begin{array}{c}{\text{Opportunity cost of Plum}}_{\text{Spain}}=\frac{\text{Units of Apples given up}}{\text{Units of Plums gained}}\\ =\frac{20}{20}\\ =1\end{array}$

So, the opportunity cost of producing 1 plum in Spain is 1 apple.

Option (b):

The opportunity cost of producing a unit of apple is lower in New Zealand (0.25 Plum) compared to Spain (1 Plum). Thus, New Zealand should specialize in the production of apples.

The opportunity cost of producing a unit of plum is lower in Spain (1 Apple) compared to that in New Zealand (4 Apples). Thus, Spain should specialize in the production of plums.

Option (c):

Before the trade, the production possibility curve of New Zealand will be having the intercepts at 60 million bushels of apple or 15 million bushels of plums. The total output combination of these two commodities will be between the lines and thus, it will be having a slope of -4. The production possibility curve of Spain will be having the intercepts at 60 million bushels of plum and 60 million bushels of apples before the trade. Thus, the slope of the curve for Spain will be -1.

According to the terms of trade of $\text{1 plum for 2 apples}$ allows New Zealand to obtain 1 plum at the cost of only 2 apples and  it will help them to increase their total quantity of plums that can be consumed to 30 million bushels. Thus, the horizontal intercept will be 30 million bushels of plums which will reduce the slope from -4 to -2 in New Zealand.

Similarly, Spain can have 2 apples for 1 plum in the international trade which will increase their total possible consumption of apples from 60 million bushels to 120 million bushels. Thus, the vertical intercept of the Spain's production possibility curve will increase to 120 million bushels. So, the slope of the production possibility curve of Spain will decrease from -1 to -0.5.

The changes are shown in the diagram as follows:

Option (d):

The mixed product of New Zealand is B and of Spain is S. According to the table, the total output of apples in New Zealand at this mixed product is 20 million bushels and the output of plums is 10 million bushels. Similarly, at the given output combination S of Spain, the total output of apples is 20 million bushes and of plums is 40 million bushels.

Thus, the total output of the apple and plum before the trade can be calculated by adding the individual quantities of apples that are produced in New Zealand and Spain together are as follows:

$\begin{array}{c}\text{Total output of Apples}={\text{Output}}_{\text{New Zealand}}+{\text{Output}}_{\text{Spain}}\\ =20+20\\ =40\end{array}$

Thus, the total output of apples before the trade was 40 million bushels.

Similarly, the total output of plums can be calculated by adding together each country’s outputs are as follows:

$\begin{array}{c}\text{Total output of Plums}={\text{Output}}_{\text{New Zealand}}+{\text{Output}}_{\text{Spain}}\\ =10+40\\ =50\end{array}$

Thus, the total output of plums before the trade was 50 million bushels.

After the specialization by New Zealand in the production of apples, the total output of apples increased to 60 million bushels. Similarly, the specialization by Spain in the production of plums increased the total output of plums to 60 million bushels. Thus, total gains from trade can be calculated by subtracting the old total outputof apples and plums from the new are as follows:

$\begin{array}{c}{\text{Gain from trade}}_{\text{Apples}}={\text{Total output}}_{\text{After trade}}-{\text{Total output}}_{\text{Before trade}}\\ =60-40\\ =20\end{array}$

Thus, the total output gain of apples is 20 million bushels.

Similarly, the total output gain in the case of plums can be calculated as follows:

$\begin{array}{c}{\text{Gain from trade}}_{\text{Plums}}={\text{Total output}}_{\text{After trade}}-{\text{Total output}}_{\text{Before trade}}\\ =60-50\\ =10\end{array}$

Thus, the total output gain in plums is 10 million bushels.

Economics Concept Introduction

Concept introduction:

Comparative advantage: It is the ability of the producer, firm or a country to produce a good or service at the lowest opportunity cost of production than the competitors.

Specialization: It is the process of identifying the product in which, the country has the comparative advantage in the form of lower opportunity cost of production. Thus, they can focus on the production of that commodity which will increase the output and they can engage in an international exchange in order to obtain the products in which they don’t have any comparative advantage.