Question

Consider two countries' situations: Country A can produce either six automobile ror twelve movies with the same amount of resources. Country B, using the same resources, can produce either five automobiles or eight movies. Using Ricardo' Theory of Comparative Advantage, determine which country would produce automobiles, which would produce movies, and the range of relative prices within which these product would trade?

Answer 1

The theory of comparative advantage says that countries should produce and trade only those commodities in which they have a comparative advantage i.e. which they can specialise in.

To find the comparative advantage of two countries A and B, let us first calculate the opportunity cost of producing movies and automobiles in each.

Country A:

Opportunity cost of producing 1 automobile = 2 movies

Opportunity cost of producing 1 movie = 1/2 automobile

Country B:

Opportunity cost of producing 1 automobile = 8/5 movies

Opportunity cost of producing 1 movie= 5/8 automobile

Since the opportunity cost of producung an automobile is lower in Country B and the opportunity cost of producing movies is lower in country A, therefore Country A would produce movies and country B would produce automobiles.