Question

Assume that Company A and Company B produce only two products, motor cars and commercial trucks using all their resources in a perfectly competitive market. The table below shows how much of each product they could in one day if they spent the whole day doing just that task. For example, Company A could produce 32 cars or 7 trucks in one day. Company A Company B Cars (x) 32 35 Tracks (y) 7 21 In case of trade and specialization who should produce what and why? Use the concepts of opportunity cost to justify your answer.

Answer 1

Table 1

According to the Ricardian theory of comparative advantage, two-country or producing agents can gain if they produce and trade the good it has a lower opportunity cost of production. The opportunity cost is foregoing the next best alternative use of resources. That is if company A can produce either 32 cars or 7 trucks, the opportunity cost of 32 cars is 7 trucks. In other words, the opportunity cost of 1 car is 7/32=0.21875 trucks.

In this way, the opportunity cost table is constructed above. Now, comparing the opportunity costs, company A has a lower opportunity cost of producing cars and B has in Trucks. Then A has a comparative advantage in cars and that of B has in trucks.

Then country A can gain if it produces and sells cars and B can gain if it produces and sells trucks.