Chat with AIExam 9: International Trade Policy, Comparative Advantage, and Outsourcing
Explain the principle of comparative advantage. Does it tell us how the gains from trade will be distributed?
(65) 
VerifiedThe principle of comparative advantage states that as long as the relative opportunity costs of producing goods (what must be given up in one good in order to get another good) differ among countries, then there are potential gains from trade. Nations should specialize in producing the products for which they have the lowest opportunity costs. However, the principle of comparative advantage does not tell us how the gains from trade will be distributed among producers, consumers, and traders.
Is a small or large country likely to gain more by trading? Why?
(83) VerifiedA small country is likely to get more of the benefit from trade (once competition has set in). The reason for this is that more opportunities are opened up by trade for small countries than for large countries.
Consider the following information about production of wine and food in England and France: England France Percentage of resources devoted to food Food Produced (tons) Wine Produced (gallons) Food Produced (tons) Wine Produced (gallons) 100 500 0 50 0 80 400 10 40 100 60 300 20 30 200 40 200 30 20 300 20 100 40 10 400 0 0 50 0 500 (a) Using the grids below, plot each country's production possibilities curve. 
(b) Which country has a comparative advantage in the production of food? Of wine? Explain.
(c) Suppose that currently England and France are not trading with each other. England is producing (and consuming) 200 tons of food and 30 gallons of wine. France is producing (and consuming) 30 tons of food and 200 gallons of wine. As an international trader, how could you take advantage of this situation and make the big bucks?
(b) Which country has a comparative advantage in the production of food? Of wine? Explain.
(c) Suppose that currently England and France are not trading with each other. England is producing (and consuming) 200 tons of food and 30 gallons of wine. France is producing (and consuming) 30 tons of food and 200 gallons of wine. As an international trader, how could you take advantage of this situation and make the big bucks? (84) Verified(a) The production possibilities curves: 
(b) England has a comparative advantage in the production of food and France has a comparative advantage in the production of wine. To see this, examine the opportunity cost of producing food and wine in each country.
Focus on the production of food. In England, if all resources are transferred away from food to wine, there is a loss of 500 tons of food and a gain of 50 gallons of wine. Thus giving up 1 ton of food results in a gain of 1/10 of a gallon of wine. Hence, the opportunity cost of one ton of food in England is 1/10 gallons of wine. Now look at France. If all resources are transferred away from food to wine, there is a loss of 50 tons of food and a gain of 500 gallons of wine. Thus giving up 1 ton of food results in a gain of 10 gallons of wine. Hence, the opportunity cost of one ton of food in France is 10 gallons of wine. Since England has a lower opportunity cost of food than France, England has a comparative advantage in the production of food.
A similar analysis will allow you to discover that France has a comparative advantage in the production of wine because its opportunity cost is of one gallon of wine is 1/10 of a ton of food whereas England's is 10 tons of food.
(c) As a trader, you can make a proposal that will allow each country to consume at a point beyond their current production possibility curve by specializing in the production of the good they have a comparative advantage in, and then trading with you for some of the other good. There are many trades you can propose that will allow you to make money. Here is one possibility.
To England: Rather than producing (and consuming) 200 tons of food and 30 gallons of wine, produce 500 tons of food. Then, give me 250 tons of food and I will give you 60 gallons of wine. Thus you now get to consume more of both goods (250 tons of food and 60 gallons of wine) than before!
To France: Rather than producing (and consuming) 30 tons of food and 200 gallons of wine, produce 500 gallons of wine. Then give me 250 gallons of wine and I will give you 60 tons of food. Thus you can consume more of both goods (60 tons of food and 250 gallons of wine) than before!
How do you make money? Compare the total production levels with the total consumption levels. England produces 500 tons of food but only 310 tons are consumed in England and France. France produces 500 barrels of wine but only 310 barrels are consumed in England and France. This leaves you with 190 tons of food and 190 barrels of wine to sell!
What is meant by the dollar-euro exchange rate? In what market is this rate determined? What factors will cause the dollar value of the euro to rise? What factors will cause the dollar value of the euro to fall?
(79) The United States dominates world markets for computer software, producing about a majority of the total world computer software, whereas Europe and Japan lag significantly behind.
(a) What possible reasons would account for this?
(b) Would you expect this to continue?
(83) Seamus "Skip" Cavanaugh often travels between Switzerland and Ireland. During his travels he has noticed that the two countries rarely trade with each other. He also noticed that the opportunity cost of producing a watch in Switzerland is 1/5 of a sweater and that the opportunity cost of producing a watch in Ireland is 5 sweaters. At the current time Switzerland's production is 30 sweaters and 200 watches, while Ireland's production is 200 sweaters and 30 watches.
(a) Which country has a comparative advantage in the production of which good? Explain.
(b) Describe how Skip can make a profit.
(c) Illustrate your answer to part (b) with a numerical example.
(82) Suppose as a result of a recession and falling interest rates in the United States, European investors buy fewer U.S. financial assets. Conversely, U.S. investors decide to buy more European stocks. Use supply/demand analysis to show graphically why the value of the euro relative to the dollar increases.
(75) Why does the distribution of costs and benefits from trade sometimes result in calls for trade restrictions?
(69) In this problem you will demonstrate your understanding of the principles of comparative advantage. You will be given data that correspond to points on the production possibility curve of two countries. From this data, you will be asked to draw the graph of the production possibility curves. For simplicity, assume the production possibility curves of these countries are straight lines. To draw these production possibility curves you need only two points on your graph. A straight line connecting these points, and extended to the axes, will represent the production possibility curve.
(a) Country A and country B are potential trading partners. Each country produces two goods: fish and wine. If country A devotes all its resources to producing fish it can produce 1,000 fish, and if it devotes all its resources to producing wine, it can produce 2,000 bottles of wine. Draw the production possibility curve for country A. In country A, what is the opportunity cost of one bottle of wine in terms of fish?
(b) If country B devotes all its resources to producing fish it can produce 3,000 fish, and if it devotes all its resources to producing wine it can produce 3,000 bottles of wine. Draw the production possibility curve for country B. In country B, what is the opportunity cost of one bottle of wine in terms of fish?
(c) Do you see any possibility of gains from trade between these two countries? Does country A have any advantage in producing either wine or fish and trading for the other good? Is this advantage an absolute or a comparative advantage?
(d) Suggest a trade between these two countries which will make them both better off. Illustrate on their production possibility curves how this will make both countries better off, by allowing them to consume a mix of wine and fish that is outside their production possibility curves.
(77) Economists have identified three insights that help in determining how the gains from trade will be distributed. Discuss each of those three insights.
(72) 
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