Two countries produce two different items, root beer and cheese
Two countries produce two different items, root beer and cheese. The table below shows the amounts of each commodity that each country can produce with 100 units of factor inputs. Consumption in each country is equal to production – that is, if trade is warranted, citizens need to receive at least as much root beer and cheese as they started with before trade. Given the following production levels, calculate the best possible trading scenario that maximizes global welfare. Remember each country has 600 productive units which they can use in any combination. Before trade, each country has allocated 50% of their productive units to each product. That is, before trade, Hokieland makes 150 gallons of root beer and 60 wheels of cheese. What should each country do if they trade? [be careful, you need to make at least as much after trade as you had before trade.] Explain your solution. Use this example to clearly explain the difference between Absolute and Comparative advantage.
Hokieland Eagleland Root Beer 2 units per gallon 4 units per gallon
Cheese 5 units per wheel 8 units per wheel
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Solution
To both products Root Beer and Cheese, each country is apportioning 50% of its productive units. According to the data provided here, for Hokieland to have one gallon of Root Beer it uses 2 productive units as compared to Eagleland which uses 4 units. For one wheel of cheese, Hokieland use 5 units whereas Eagleland use 8 units.
By combining the production of both countries we get the following
Total Root Beer production is =2/5*300 + ½*300 = 270 units
Total Cheese production is = 5/2*300 + 8/4*300 = 1,350 units
This shows that Hokieland has Absolute advantage compared to Eagleland since it produces more of the Root Beer and also Cheese (Loyalka, Prashant Kumar, et al, nd). Otherwise speaking Eagleland uses more productive units to make one gallon of Root Beer and one wheel of Cheese in comparison with Hokieland.
Comparative advantage is seen within the same country. Hokieland stands to be more productive in case of Root Beer as co...
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