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 nations should yield and trade only those merchandises in which they have a reasonable advantage i.e. which they are specialize in.

To compute the comparative advantage of two nations A and B, let us first compute the opportunity cost of making movies and vehicles in each.

Country A:

Opportunity cost of making 1 automobile = 2 movies

Opportunity cost of making 1 movie = 1/2 automobile

Country B:

Opportunity cost of making 1 automobile = 8/5 movies

Opportunity cost of making 1 movie= 5/8 automobile

Since the prospect cost of making an automobile is lesser in Country B and the prospect cost of making movies is lesser in country A, thus Country A would make movies and country B would make automobiles.