King’s College

Secondary 7A (2008-2009)
Economics
Assignment

Source: Chapter 14: Gains from Trade, Advanced Level Macroeconomics 2 by Dr. Lam Pun Lee
Date of submission: 02/12/2008 (Tue)

Attempt the following questions on single-lined paper.

2 Assume the following price data in the U.S.A. and the U.K. in their respective domestic currencies.
Item U.K. U.S.A.
Shoes (1 pair) £1 $3
Coats (1 unit) £2 $4

(a) What is the evidence that there exists a basis for mutually beneficial two-way trade? Explain.
(b) The U.S.A. has a comparative advantage in which commodity? In which commodity will the U.K.
specialise? Explain.

3. The following table shows the labour inputs for production:

Explain the absolute and comparative advantages of the two countries.
Country Good X Good Y
Country A 1L 4L
Country B 2L 3L
1
4. Given one unit of resources, Country A and Country B can produce the following outputs:
Country
Goods A B
X 3 1
Y 4 2

(a) Find the comparative advantages of the two countries.

(b) Will both countries benefit from trade if the terms of trade is 1X = 1Y?

5. The following shows the labour required in the production of a unit of Good X and a unit of Good Y:
Country Good X Good Y
Country A 10L 10L
Country B 20L 50L

Show how the two countries can benefit from trade.

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Suggested Solutions:
2. (a) The opportunity costs of producing shoes and coats are different in the two countries.
(b) In the U.K., the opportunity cost of producing one pair of shoes is 1/2 unit of coat; since if £1 is spent
on producing a pair of shoes, this amount cannot then be used to produce 1/2 unit of coat.
In the U.K., conversely, the opportunity cost of producing one coat is two pairs of shoes; since if £2
are spent on producing a unit of coat, this amount cannot be use to produce two pairs of shoes.
In the U.S.A., the opportunity cost of producing one pair of shows and one unit of coat are 3/4 unit of
coat and 4/3 pairs of shoes respectively.
Therefore, the U.S.A. has a comparative advantage in producing coats while the U.K. has a
comparative advantage in producing shoes; the former should specialise in producing coats and the
latter in producing shoes.

3. If labour inputs are homogenous in the two countries, then Country A has an absolute advantage in the
production of Good X while Country B has an absolute advantage in the production of Good Y. A country
has an absolute advantage over another in the production of a good if it can produce more of the product
with the same amount of resources, or if it can produce the same product with fewer resources.
The cost of producing 1 unit of Good X is 0.25 (1/4) unit of Good Y in Country A, compared with 0.67
(2/3) unit of Good Y in Country B, so Country A has a comparative advantage in the production of Good
X. On the other hand, the cost of producing 1 unit of Good Y is 4 units of Good X in Country A,
compared with 1.5 (3/2) units of Good X in Country B, so Country B has a comparative advantage in the
production of Good Y.

4. (a) In Country A, the cost of producing one unit of Good X is 1.33 (4/3) units of Good Y, while it is 2
units of Good Y in Country B. So Country A has a comparative advantage in producing Good X.
In Country A, the cost of producing one unit of Good Y is 0.75 (3/4) unit of Good X, while it is 0.5
(1/2) unit of Good X in Country B. So Country B has a comparative advantage in producing Good Y.
(b) Yes, both countries will benefit from trade since the terms of trade lies between the domestic
exchange ratios (or opportunity costs) of the two goods for the two countries.

5. In Country A, the cost of producing one unit of Good X is 1 unit of Good Y, while it is 0.4 unit of Good Y
in Country B. So Country B has a comparative advantage in producing Good X.
In Country A, the cost of producing one unit of Good Y is 1 unit of Good X, while it is 2.5 unit of Good
X in Country B. So Country A has a comparative advantage in producing Good Y.

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