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Comparative advantage explanation

Suppose that, with a given unit of labour, India can produce 40 basketball hoops or 60 basketballs and Nepal can produce 10 basketball hoops or 30 basketballs. This scenario is illustrated below.

output
hoops (H) balls (B)
India 40 60
Nepal 10 30

a.) Explain absolute and comparative advantage for India and Nepal.

b.) If each country has 1000 person-days of labour, construct each country's production-possibility curves.

c.) If Nepal wants to consume equal amounts of both goods (as many units of hoops as balls), how much of each good will be produced and consumed if there is no trade between the two countries?

d.) Assume that the equilibrium terms of trade are 1H=2B. If Nepal still wants to consume equal amounts of both hoops and balls, show its points of production, consumption, and the amounts of exports and imports.

e.) Show the gains from trade for Nepal.

Solution Preview

a.) Explain absolute and comparative advantage for India and Nepal.
The cost of producing 60 balls in India is 40 hoops, so each ball costs is 4/6 = 2/3 of a hoop. The cost of a ball in Nepal is likewise calculated to be 1/3 of hoop. The country with the lowest cost of balls in terms of hoops should specialize in balls. This would be Nepal. The cost of hoops in India is 3/2 of a ball, while in Nepal it is 3 balls. So India should make hoops.

b.) If each country has 1000 person-days of labour, construct each country's production-possibility curves.
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Solution Summary

Use of PPFs to determine gains from trade

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