Question

# Number of swords that can be produced in 1 hour Number of shields that can be...

 Number of swords that can be produced in 1 hour Number of shields that can be produced in 1 hour Gondor 12 10 Rohan 4 8

Refer to the table above. Suppose that Gondor has a labor supply of 20 hours while the labor supply of Rohan is 50 hours. If each country dedicates its labor supply only to the production of the good in which it displays comparative advantage, and if they trade 3 swords in return of 5 shields (i.e. the international price of a shield is 0.6 swords), which country would gain from trade?

 Gondor would benefit from trade while Rohan would not benefit from trade. Rohan would benefit from trade while Gondor would not benefit from trade. Both countries would benefit from trade because it would allow each country to consume a bundle of goods that is unattainable in the case of autarky. Neither country would benefit from trade because they would end up with bundles of goods that they could have already produced by themselves.

Solution:

Gondor can produce either 12 swords or 10 shields in an hour. Thus, opportunity cost of producing 1 shield is 12/10 = 1.2 swords. Similarly, for Rohan, opportunity cost of producing 1 shield is 4/8 = 0.5 swords. As the opportunity cost of producing shield is lower for Rohan (0.5 < 1.2), Rohan has a comparative advantage in producing shields while Gondor has a comparative advantage in production of swords.

When the international price (or exchange rate of goods) is within the opportunity cost values for the two participants, both gain from trade. With international price of 1 shield = 0.6 swords, as 0.5 < 0.6 < 1.2, that is as price of shield lies between opportunity cost of producing a shield of the two participants here, with this rate, both must gain from trade.

Thus, the correct option is (C).

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