Comparative Advantage and Gains to Trade

Comparative Advantage and Gains to Trade - Comparative...

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August 29, 2005 Comparative Advantage and Gains to Trade
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August 29, 2005 Suppose we have two countries, Germany and England, producing two goods, Wine and Cheese. The hours of labor required to produce these goods in each country are given in the table below: Wine (Hours/Bottle) Cheese (Hours/Pound) England 4 6 Germany 6 8 Are there potential gains to trade between these two countries?
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August 29, 2005 Wine (Hours/Bottle) Cheese (Hours/Pound) England 4 6 Germany 6 8 Economist Adam Smith would argue NO. England has an Absolute Advantage in production of both goods. It can produce each good with less labor than is required in Germany. Economist David Ricardo corrected Smith’s reasoning, arguing that benefits to trade exist so long as the countries have Comparative Advantages in production. England: 4 Hours/Bottle 6 Hours/Pound Germany: 8 Hours/Pound 6 Hours/Bottle = = 2/3 Pound/Bottle or 3/2 Bottles/Pound 3/4 Pound/Bottle or 4/3 Bottles/Pound England has a comparative advantage in production of Wine, giving up less cheese per bottle in production. Germany has a comparative advantage in production of Cheese.
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August 29, 2005 “Enchiladas” “Tacos” 10 10 5 15 5 15 US Mexico M U Consider the graph below, which shows the Production Possibilities Frontiers for Mexico and the U.S. In Autarky: The United States is currently producing and consuming basket U. Mexico is producing and consuming basket M
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August 29, 2005 “Enchiladas” “Tacos” 10 10 5 15 5 15 US Mexico M U How many “Tacos” are jointly produced and consumed by these countries in autarky? “Enchiladas?” Illustrate the joint production and consumption of Tacos and Enchiladas by these two countries as basket A in this graph.
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This note was uploaded on 04/07/2008 for the course ECON 252 taught by Professor Robertholand during the Fall '08 term at Purdue University.

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Comparative Advantage and Gains to Trade - Comparative...

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