Answer all 6 questions

The data in the table below assume that with the same quantity of resources, both Australia and Philippines produce food and computers. Australia can make 1,000 computers or 2,000 units of food a day, and Philippines can make 200 computers or 1,200 units of food in a day.

Amount Produced of Each Good per Day per Country

Computers Food

Australia 1,000 2,000

Philippines 200 1,200

1. Illustrate the production possibilities (PPC) for both countries
2. Which country has an absolute advantage in the production of both goods? Why?
3. Which country has a comparative advantage in computers production? Explain.
4. Which country should specialize in computers production? Explain.
5. Which country has a comparative advantage in food production? Explain.
6. Which country should specialize in food production? Explain.

Opportunity Cost, Comparative Advantage, and Specialization

Absolute Advantage versus Comparative Advantage

In the U.S., a worker can produce per day 8 units of wheat or 4 units of cloth.

In India, a worker can produce per day 4 units of wheat or 3 units of cloth.

Looking at this example, the U.S. has an absolute advantage-greater productivity- in producing both wheat and cloth. Since one worker can produce more of either good in the U.S. than in India, the U.S. is the more efficient producer of both goods. It might seem that since the U.S. is the more efficient producer of both goods, there would be no need for trade with India. But Absolute Advantage is not the critical consideration.

What matters in determining the benefits of international trade is Comparative Advantage (lower opportunity cost). For example, the opportunity cost (O.C.) of producing wheat is what must be given up in cloth using the same resources, vice-versa.

Since one U.S. worker can produce 8 units of wheat or 4 units of cloth, if we take a worker from cloth production and move him to wheat production, we gain 8 units of wheat and lose 4 units of cloth. So the opportunity cost of producing 1 unit of wheat is 4/8 or (0.50) unit of cloth.

Applying the same thinking to India, we find that one worker can produce 4 units of wheat or 3 units of cloth. So, the O.C of producing 1 unit of wheat in India is (0.75).

Applying the same argument, 2 units of wheat must be given up in the U.S. to produce 1unit of cloth; 1.33 units of wheat must be given up in India to produce 1 unit of cloth.

To make it easy to understand, let's use dollar amount:

To produce 1 unit of wheat it costs: the U.S. $0.50 and India $0.75

To produce 1 unit of cloth it costs: the U.S. $2 and India $1.33

Clearly the figures show that the U.S. has a comparative advantage (least cost) in producing wheat and India has a comparative advantage (least cost) in producing cloth.

So, on the basis of comparative advantage, India will specialize in cloth production and the U.S. will specialize in wheat production. The two countries will then trade with each other to satisfy the domestic demand for both goods.