Question

Assume labor and capital are the only two inputs. Digitopolis is a capital-abundant country that produces personal computers and fax machines. Computer production is capital intensive, and fax production is labor intensive. Capital can be employed in either the computer or the fax industry and can move easily back and forth between the two. Labor is specialized; some labor is suited to produce personal computers and other labor to produce fax machines. "Computer labor" is useless in producing fax machines, and "fax labor" is useless in producing computers. If Digitopolis opens trade with a labor-abundant country with identical tastes, what will happen in the short run to:

Answer 1

Following the Ricardian Model of Comparative Advantage, both Digitopolis and the labor-abundant country will specialize at producing what each does best, according to its factors endowment.

This means that Digitopolis will shift its production to computers as it is a capital intensive activity and its opportunity cost for computers production is lower, while the second country, being labor-abundant, will specialize on producing fax machines.

Step-by-step explanation:

The Ricardian Model of Comparative Advantage assumes that countries benefit from international trade as they will specialize in producing goods where they hold comparative advantage, that is, where their opportunity cost is lower. The opportunity cost describes the trade-off between choosing to produce one good or the other based on inputs availability and efficiency. In this case, capital is abundant in Digitopolis, so it is evident that the opportunity cost of shifting output to a capital-intensive industry (computers) will be less than producing labor-intensive goods (fax machines).

Being a capital-abundant country, for Digitopolis the opportunity cost of producing fax machines is higher than for producing computers, so it is less efficient for this country to focus on producing fax machines. Thus, it will be more productive that it specializes on producing computers.

On the other hand, considering that the second country is labor-abundant, it is better that it specializes on producing fax machines, as its opportunity cost here is lower.

Finally, both countries will benefit from trade, as overall production of computers and fax machines will increase. Digitopolis will produce much more computers and the second country more fax machines than in the pre-trade situation, because both countries will be employing their inputs more efficiently and productivity will increase.