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

In an international trade model involving two nations, Country X and Country Y, the labor-hours required to produce one unit of Machinery and one unit of Fertilizer are shown in the table below:

CountryMachinery (labor-hours)Fertilizer (labor-hours)
Country X123
Country Y84

Assuming both countries trade according to the principle of comparative advantage, what is the maximum number of units of Fertilizer that Country X is willing to exchange for 11 unit of Machinery?

Answer: 4 units of Fertilizer

Answer

4 units of Fertilizer
In an input-based trade model, the domestic opportunity cost of producing 11 unit of Machinery in Country X is 12 labor-hours3 labor-hours=4 units of Fertilizer\frac{12 \text{ labor-hours}}{3 \text{ labor-hours}} = 4 \text{ units of Fertilizer}. For Country X to be willing to import Machinery rather than produce it domestically, the price of 11 unit of Machinery must not exceed its internal opportunity cost of 44 units of Fertilizer.

Step-by-Step Solution

1
Calculate the opportunity cost of Machinery in Country X using input labor-hours.
Opportunity cost of 11 unit of Machinery in Country X = 123=4\frac{12}{3} = 4 units of Fertilizer.
In input-based models, opportunity cost of Good A is the ratio of labor-hours required for Good A to labor-hours required for Good B.
2
Calculate the opportunity cost of Machinery in Country Y using input labor-hours.
Opportunity cost of 11 unit of Machinery in Country Y = 84=2\frac{8}{4} = 2 units of Fertilizer.
Determines Country Y's domestic trade-off and minimum acceptable export price.
3
Determine the maximum willingness to pay for Country X.
Maximum acceptable exchange rate = 44 units of Fertilizer per unit of Machinery.
Country X will not pay more than its internal cost to produce Machinery domestically (44 units of Fertilizer).

Key Concept

Upper and lower bounds of mutually beneficial terms of trade derived from input-based comparative advantage.
Estimated Time:2m 0s
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Theories of International Trade (Absolute and Comparative Advantage)

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