*CHAPTER 2
(Core Chapter)
COMPARATIVE ADVANTAGE
ANSWERS TO REVIEW QUESTIONS AND PROBLEMS
1. The mercantilists believed that the way for a nation to become rich and powerful was to
export more than it imported. The resulting export surplus would then be settled by an inflow of gold and silver and the more gold and silver a nation had, the richer and more powerful it was. Thus, the government had to do all in its power to stimulate th e nation’s exports and discourage and restrict imports. However, since all nations could not simultaneously have an export surplus and the amount of gold and silver was fixed at any particular point in time, one nation could gain only at the expense of other nations. The mercantilists thus preached economic nationalism, believing that national interests were basically in conflict.
Adam Smith, on the other hand, believed that free trade would make all nations better off.
All of this is relevant today because many of the arguments made in favor of restricting international trade to protect domestic jobs are very similar to the mercantilists arguments made three or four centuries ago. That is why we can say that “mercantilism is alive and well in the twenty-fi rst century”. Thus we have to be prepared to answer and
demonstrate that these arguments are basically wrong.
2. According to Adam Smith, the basis for trade was absolute advantage, or one country being
more productive or efficient in the production of some commodities and other countries being more productive in the production of other commodities.
The gains from trade arise as each country specialized in the production of the commodities in which it had an absolute advantage and importing those commodities in which the nation had an absolute disadvantage.
Adam Smith believed in free trade and laissez-faire, or as little government interference with the economic system as possible. There were to be only a few exceptions to this policy of laissez-faire and free trade. One of these was the protection of industries important for national defense.
3. Ricardo’s law of comparative advantage is superior to Smith’s theory of absolute advantage
in that it showed that even if a nation is less efficient than or has an absolute disadvantage in the production of all commodities with respect to the other nations, there is still a basis for
beneficial trade for all nations.
The gains from trade arise from the increased production of all commodities that arises when each country specializes in the production of and exports the commodities
of its comparative advantage and imports the other commodities.
A nation that is less efficient than others will be able to export the commodities of its
comparative advantage by having its wages and other costs sufficiently lower than in other
nations so as to make the commodities of its comparative advantage cheaper in terms of the same currency with respect to the other nations.
4.    a. In case A, the United States has an absolute and a comparative advantage in wheat and
the United Kingdom in cloth. In case B, the United States has an absolute advantage (so that the United Kingdom has an absolute disadvantage) in both commodities. In case C, the
United States has an absolute advantage in wheat but has neither an absolute advantage nor disadvantage in cloth. In case D, the United States has an absolute advantage over the
United Kingdom in both commodities.
b. In case A, the United States has a comparative advantage in wheat and the United
Kingdom in cloth. In case B, the United States has a comparative advantage in wheat and the United Kingdom in cloth. In case C, the United States has a comparative advantage in wheat and the United Kingdom in cloth. In case D, the United States and the United Kingdom have
a comparative advantage in neither commodities.
5.    a. The United States gains 1C.
b. The United Kingdom gains 4C.
c. 3C < 4W < 8C.
d.  The United States would gain 3C while the United Kingdom would gain 2C.
6.    a. The cost in terms of labor content of producing wheat is 1/4 in the United States and 1 in
the United Kingdom, while the cost in terms of labor content of producing cloth is 1/3 in the United States and 1/2 in the United Kingdom.
b. In the United States, Pw=$1.50 and Pc=$2.00.
c. In the United Kingdom, Pw=£1.00 and Pc=£0.50.
7. The United States has a comparative disadvantage in the production of textiles. Restricting
textile imports would keep U.S. workers from eventually moving into industries in which the United States has a comparative advantage and in which wages are higher.
8. Ricardo’s explanation of the law of comparative is unacceptable because it is based on the
labor theory of value, which is not an acceptable theory of value.
The explanation of the law of comparative advantage can be based on the opportunity cost doctrine, w
hich is an acceptable theory of value.
unequal9. The production possibilities frontier reflects the opportunity costs of producing both
commodities in the nation.
The production possibilities frontier under constant costs is a (negatively sloped) straight line.
The absolute slope of the production possibilities frontier reflects or gives the price of the commodity plotted along the horizontal axis in relation to the commodity plotted along the vertical axis.
10.    a. See Figure 1.1.
b. In the United States Pw/Pc=3/4, while in the United Kingdom, Pw/Pc=2.
c. In the United States Pc/Pw=4/3, while in the United Kingdom Pc/Pw=1/2.
d. See Figure 1.2.
The autarky points are A and A' in the United States and the United Kingdom, respectively.
The points of production with trade are B and B' in the United States and the United Kingdom, respectively.
The points of consumption are E and E' in the United States and the United Kingdom, respectively. Th
e gains from trade are shown by E > A for the U.S. and E' > A' for the U.K.
ANSWERS TO REVIEW QUESTIONS AND PROBLEMS
1.    a. Increasing opportunity costs arise because resources or factors of production are not
homogeneous (i.e., all units of the same factor are not identical or of the same quality) and not used in the same fixed proportion or intensity in the production of all commodities.
This means that as the nation produces more of a commodity; it must utilize resources that become progressively less efficient or less suited for the production of that commodity. As a result, the nation must give up more and more of the second commodity to release just
enough resources to produce each additional unit of the first commodity (i.e., it faces
increasing costs).
b. In the real world, the production frontiers of different nations will usually differ because
of differences in factor endowments and technology.
2.    a. See Figure
3.1.
b. The slope of the transformation
curve increases as the nation
produces more of X and decreases
as the nation produces more of Y.
These reflect increasing
opportunity costs as the nation
produces more of X or Y.
3.    a. See Figures 3.2a and 3.2b.
b. Nation 1 has a comparative advantage in X and Nation 2 in Y.
c. If the relative commodity price line in autarky has equal slope in both nations. This is rare.
4.    a.  See Figures 3.3a and 3.3 b. Points B and B’ are the production points in Nations 1 and 2,
respectively, with specialization and trade and E and E’ are the consumption points.
b. Nation 1 gains by the amount by which community indifference curve III (point E) is
above indifference curve I (point A). Nation 2 gains to the extent that community indifference curve III’ (point E’) is above indifference curve I’ (point A).
5.    a. The equilibrium-relative commodity price in isolation is the relative price that prevails
in the nation without trade or in autarky.
b. The equilibrium-relative commodity price in isolation for the commodity plotted along
the horizontal axis is given by the (absolute) slope of the tangent of the production frontier and the community indifference curve at the point of production and consumption in the
nation in isolation.
c. The nation with the lower equilibrium relative commodity price in isolation or autarky
has a comparative advantage in the commodity measured along the commodity axis and a comparative disadvantage in the commodity measured along the vertical axis.
6.    a.  Nation 1 is better off at point E’ than at point A’ because point E’ is on higher community
indifference curve III than at point A, which is on lower community indifference curve I.
b.  Nation 1 consumes less of commodity Y at point E’ (40Y) than at point A’ (60Y) because
P Y/P X is much higher at point E’ (P B’ =1) than at point A’ (P A’ =1/4, the inverse of P X/P Y=4).
7.    a. The reason for incomplete specialization under increasing costs is that as each nation
specializes in the production of the commodity of its comparative advantage, the relative commodity price in each nation moves toward each other (i.e., become less unequal) until they are identical in both nations. At that point, it does not pay for either nation to continue to expand the production of the commodity of its initial comparative advantage. This occurs before either nation has completely specialized in production.
b. Under constant costs, each nation specializes completely in production of the
commodity of its comparative advantage (i.e., produces only that commodity). The reason is that since it pays for the nation to obtain some of the commodity of its comparative
disadvantage from the other nation, then it pays for the nation to get all of the commodity of its comparative disadvantage from the other nation (i.e., to specialize completely in the production of the commodity of its comparative advantage).
8. See Figure 3.5 (Please disregard Figure 3.4, which shows how to derive the demand and

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