9/8/11

If two countries specialize, how many additional units of a good can be produced?


This post will go over a common question asked in economics about the time you are going over PPFs, comparative and absolute advantage and gains from trade.  They typically give you information in the following format:

Canada
Mexico
Bacon (in tons)
Tacos (in tons)
Bacon (in tons)
Tacos (in tons)
0
135
0
75
50
90
5
50
100
45
10
25
150
0
15
0

This table gives you information about two countries, and shows you the information that would be required to construct a production possibility frontier (PPF).  The first question is using asking about which country has the comparative and absolute advantage in each good.  For the above example,
we can figure out who has the absolute advantage in each relatively quickly.

Remember that absolute advantage means that a country or person can produce more of a given good given the same resources.  We can see from the information above, that Canada can produce more bacon or tacos than Mexico can (150>15 and 135 > 75).  This means that Canada has the absolute advantage in both bacon and tacos.  The next step is to figure out who has the comparative advantage. 

Remember that comparative advantage means that a country can produce a good at a lower opportunity cost than anyone else.  In order to figure this out we need to calculate the opportunity cost for each good for both countries.  Let’s look at the opportunity of Bacon first, and begin with Canada.

Canada can either produce 150 bacon or 135 tacos (if they specialize completely).  So the opportunity cost of 150 bacon is 135 tacos.  Divide 135 by 150 to get the opportunity cost of 1 bacon, which will be 0.9 tacos.  For Mexico, the opportunity cost of 15 bacon is 75 tacos.  Divide 75 by 15 to get the opportunity cost of 1 bacon which will be 5 tacos.  So Canada has the comparative advantage in bacon because they only have to give up 0.9 tacos while Mexico has to give up 5 tacos.  Likewise, Mexico only has to give up 0.2 bacon for a taco (using the same process as above) and Canada has to give up 1.1 bacon for a taco.  So Mexico has the comparative advantage in tacos.

Since we know which country has the comparative advantage in which good, we can then allow them to specialize in that good and see what happens to the economy.  First let’s suppose that Canada is currently producing 100 bacon and 45 tacos, while Mexico is producing 10 bacon and 25 tacos.  This means that the whole economy is producing 110 bacon (100+10) and 70 tacos (45+25).

If we allow the countries to specialize we will now have 150 bacon from Canada, and 75 tacos from Mexico.  This means that we have 40 more bacon in the economy (150-110) and 5 more tacos in the economy (75-70) as a result from specialization.

Spread the knowledge!
Technorati Digg This Stumble Stumble Facebook Twitter

0 comments:

Post a Comment

 

I invite you to join dropbox!

I invite you to join dropbox!
Use the above link for an extra 250MB Free!
All content on this site is the copyright of webmaster. No re-posting is permitted. Powered by Blogger.
VigLink badge

Post Archive

| FreeEconHelp.com, Learning Economics... Solved! © 2009. All Rights Reserved | Template Style by My Blogger Tricks .com | Design by Brian Gardner Back To Top