Answer to Question #272657 in Macroeconomics for Cmd

Question

Consider the following situation for Upland and Downland. Each country half of its resources in Banana and half in Apple.

Apple. Banana

Upland 450 80

Downland 60 60

a. Does the figure represent Absolute or Comparative advantage or both?

b. What is the opportunity cost of apple for each country?

c. By how much will total output increase when the countries ( Download and Upland) specialize.

Answer 1

a)     The figure depicts Absolute's involvement in the production of both apples and bananas. More apples and bananas are produced in the country.

b)     The opportunity cost of generating an additional unit of Apple is equal to the quantity of bananas produced per hour divided by the quantity of apples produced per hour. Upland's opportunity cost of creating an extra Apple unit is 60/450. Uplands' opportunity cost of manufacturing an extra unit of Apple is 0.13 banana units.

Downland's opportunity cost of generating an additional Apple unit is 60/80. Producing an extra unit of Apple for Download=0.75 units of Banana incur an opportunity cost. Upland has a competitive advantage in apple production since he has a lower opportunity cost than Download.

c)     Specialization may provide economies of scale, resulting in long-run average cost reductions as output rises. Specialization based on comparative advantage leads to more efficient use of global resources. The trading nations have access to a greater number of outputs. In Apple, Upland has a comparative advantage, while Download has a comparative advantage in Banana. Upland may get a unit of Apple for only 100 units of labor by trading Banana for labor, rather than 110 units of labor to create the Apple itself, by specializing and then trading. Similarly, Download can specialize on Apple and trade for a unit of Banana for only 80 units of labor, rather than the 90 units of labor required to produce it domestically. Each country will keep trading until the price matches the opportunity cost, at which time it will chose to produce the other good domestically rather than trade it. Both countries benefit from specializing and then trading (in this situation with no trade expenses).