Australia and Malaysia can both produce aluminium and fertiliser.

In a year Malaysia can produce either 20 million tonnes of aluminium or 16 million tonnes of fertiliser or any linear combination, for example, 10 million tonnes of aluminium and 8 million tonnes of fertiliser.

In a year Australia can produce either 80 million tonnes of aluminium or 40 million tonnes of fertiliser or any linear combination, for example, 64 million tonnes of aluminium and 8 million tonnes of fertiliser.

1.Explain which country has the absolute advantage in:

• aluminium production?
• fertiliser production?

2. Calculate and explain what is the opportunity cost of producing 1 tonne of fertiliser:

• for Australia?
• for Malaysia?
• Explain which country has the comparative advantage and should specialise in fertiliser production.

3. Calculate and explain what is the opportunity cost of producing 1 tonne of aluminium:

• for Australia?
• for Malaysia?
• Explain which country has the comparative advantage and should specialise in aluminium production.

4. Explain what is the maximum Australia would pay and the minimum Malaysia would accept (in terms of tonnes of aluminium) for a tonne of fertiliser? What does this suggest the price for a tonne of fertiliser will range over if Australia and Malaysia trade?

5. Suppose that each country requires exactly 8 million tonnes of aluminium and wants as much fertiliser as it can get. Malaysia and Australia negotiate that price of a tonne of fertiliser will be 1.75 tonnes of aluminium. Demonstrate that Malaysia and Australia can both be better off through specialisation and trade than if they each produced their own aluminium requirement.