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Difficulty: EasyTheories of International Trade (Absolute and Comparative Advantage)

The table below shows the output of Palm Oil (in barrels) and Cassava (in bags) produced per worker per day in Country M and Country N:

CountryPalm Oil (barrels)Cassava (bags)
Country M1020
Country N1236

According to the theory of comparative advantage, which commodity should Country M specialize in and export?

  1. Palm Oil, because its opportunity cost of producing Palm Oil is lower than that of Country NAnswer
  2. B
    Cassava, because Country N has an absolute advantage in producing both goods
  3. C
    Palm Oil, because the money price of producing Palm Oil in Country M is lower than in Country N
  4. D
    Cassava, because Country M produces more bags of Cassava than barrels of Palm Oil

Answer

Palm Oil, because its opportunity cost of producing Palm Oil is lower than that of Country N
The correct response identifies that Country M should specialize in Palm Oil because its opportunity cost of producing 1 barrel of Palm Oil (2 bags of Cassava2\text{ bags of Cassava}) is lower than Country N's opportunity cost (3 bags of Cassava3\text{ bags of Cassava}). Under David Ricardo's theory of comparative advantage, nations specialize in producing goods for which they sacrifice less of an alternative commodity.

Step-by-Step Solution

1
Calculate the opportunity cost of 1 barrel of Palm Oil in Country M
Opportunity cost = 20 bags of Cassava10 barrels of Palm Oil=2 bags of Cassava\frac{20\text{ bags of Cassava}}{10\text{ barrels of Palm Oil}} = 2\text{ bags of Cassava}
Opportunity cost of good X in output terms is the output of good Y foregone divided by the output of good X.
2
Calculate the opportunity cost of 1 barrel of Palm Oil in Country N
Opportunity cost = 36 bags of Cassava12 barrels of Palm Oil=3 bags of Cassava\frac{36\text{ bags of Cassava}}{12\text{ barrels of Palm Oil}} = 3\text{ bags of Cassava}
This establishes Country N's cost of producing one unit of Palm Oil.
3
Compare opportunity costs to determine comparative advantage
Country M has a lower opportunity cost for Palm Oil (2<32 < 3), so Country M should specialize in Palm Oil.
A country has a comparative advantage in the commodity where its opportunity cost is lower.

Key Concept

Theory of Comparative Advantage
Estimated Time:45s
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Topics

Theories of International Trade (Absolute and Comparative Advantage)

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