Helwan University

Faculty of Commerce & Business Administration

Business Information Systems (BIS)

Fall 2014/2015
Economics of Foreign Trade

Instructors: Dr. Marwa Assem & Dr. Ahmed Abdel-Halim

Solution Key to Assignment 1

Question 1:
Suppose you are given the following information about the productivity of labor in Japan
and India.
Table 1.1: Number of units produced per labor hour
LCDs

Japan
2

India
1

Textiles

A. In table 1.2 below, calculate the labor cost of producing each good in each country.
Labor cost is the inverse (reciprocal) of productivity. If labor in Japan can produce 2 LCDs
per labor hour, so the cost of each LCD is labor hour; and so forth.
Table 1.2: Labor Costs (in labor hours)
Japan

India

LCDs
Textiles
B. Which country has an absolute advantage in LCDs? In textiles? Explain.
-

Since 2 > 1 (or 0.5 < 1), Japan can produce LCDs at a higher productivity (lower
labor cost). Therefore, Japan has an absolute advantage in producing LCDs.

Since 8 > 5 (or 0.125 < 0.2), India can produce textiles at a higher productivity
(lower labor cost). Therefore, India has an absolute advantage in producing textiles.

C. Could international trade occur and be mutually beneficial based on absolute

advantage? Why or why not?
Yes. Because each country has an absolute advantage in producing one commodity and has
an absolute disadvantage in producing the other commodity. Trade will be mutually
beneficial if Japan specializes in producing and exporting LCDs and India specializes in
producing and exporting textiles.
D. Calculate the opportunity costs of producing LCDs and Textiles in each country. Show
your calculations. Summarize your results in table 1.3 below.

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In each country:
-

The opportunity cost of an LCD is given by:

The opportunity cost of a unit of textiles is given by:

Using productivity:
Table 1.3: Units Opportunity Costs
Japan

India

LCDs
Textiles
Using labor costs:
Table 1.3: Units Opportunity Costs
Japan

India

LCDs
Textiles

E. Based on your answer in C, which country has a comparative advantage in LCDs? In

textiles? Explain.
-

Since 2.5 < 8, Japan can produce LCDs at a lower opportunity cost. Therefore,
Japan has a comparative advantage in producing LCDs.

Since 0.125 < 0.4, India can produce textiles at a lower opportunity cost. Therefore,
India has a comparative advantage in producing textiles.
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Suppose that each country has a total of 100 labor hours. Before specialization, each
country allocates 50 labor hours in the production of each good. Suppose further that once
trade occurs, the two countries will exchange 80 LCDs for 320 units of textiles.
F. In table 1.4 below, show the pattern of consumption and production before
specialization and trade in both countries.
Table 1.4: Production & Consumption before
Specialization
Japan

India

LCDs
Textiles
G. In table 1.5 below, show the pattern of production after specialization in both countries.
-

Japan has a comparative advantage in producing LCDs. Therefore, Japan should

specialize in producing and exporting LCDs

India has a comparative advantage in producing textiles. Therefore, India should

specialize in producing and exporting textiles.

Specialization is complete!
Table 1.5: Production after Specialization
Japan
LCDs
Textiles

India
0

H. What are the total gains in world production due to specialization based on comparative
advantage?
-

Total world production in LCDs increased from 150 (100 + 50) to 200. A gain of 50
LCDs. Similarly, total world production in textiles increased from 650 (250 + 400) to
800. A gain of 150 units of textiles.

I. What is the international rate of exchange in this case? Will trade be mutually
beneficial under this rate? Why or why not? (Hint: What is the range for the
international rate of exchange that makes trade mutually beneficial?)
-

The two countries will exchange 80 LCDs for 320 units of textiles Therefore; the
international rate of exchange is 1 LCD for 4 units of textiles (1L = 4T).

The range of mutually beneficial trade is that the international rate of exchange should
lie between the two opportunity costs. That is: it should be somewhere between 1 LCD
for 2.5 units of textiles (1L = 2.5T) to 1 LCD for 8 units of textiles (1L = 8T).

The current rate lies in this range, so trade will be mutually beneficial.

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J. In table 1.6, show the pattern of consumption after trade in both countries.
Table 1.6: Consumption after Trade
Japan

India

LCDs
Textiles

K. Calculate the gains from trade to each country in table 1.7 and show that international
trade based on comparative advantage is mutually beneficial.
Table 1.7: Gains from Trade (in units of the two goods)
LCDs

Japan
120 100 = +20

India
80 50 = +30

Textiles

320 250 = +70

480 400 = +80

L. Express the gains from trade you calculated in part K in terms of labor hours saved.
Table 1.7: Gains from Trade (in labor hours)
LCDs

Japan
+20 0.5 = +10

India
+30 1 = +30

Textiles

+70 0.2 = +14

+80 0.125 = +10

Both Goods

+24 LHs

+ 40 LHs

Just multiply the gains (in units) by their relative labor costs, then add them up!
Japan saved 24 labor hours, while India saved 40 labor hours.

Question 2:
Suppose in Finland a worker can produce either 32 mobile phones or 4 boats while in
Canada a worker can produce either 40 mobile phones or 10 boats..
Table 2.1: Production Possibilities per worker
Finland

Mobile phones
32

Boats
4

Canada

40

10

A. Which country has an absolute advantage in mobile phones? In boats? Explain.

Since Canada can produce more per worker than Finland in both goods, Canada enjoys
absolute advantage in the production of both.

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B. Calculate the opportunity costs of producing one unit of each good in each country.
Write your answers in Table 2.2 below.
Table 2.2: Opportunity Costs per unit
Mobile phones
Boats
4/32 = 0.125 B
32/4 = 8 MP
Finland
Canada

10/40 = 0.25 B

40/10 = 4 MP

C. Which country has a comparative advantage in mobile phones? In boats? Explain.

-

Finland can produce MP at a lower opportunity cost (0.125 < 0.25). Therefore,
Finland has a comparative advantage in producing MP.

Canada can produce B at a lower opportunity cost (4 < 8). Therefore, Canada has
a comparative advantage in producing B.

Suppose each country has 1,000 workers.

D. Before specialization, each country devotes 40% of its labor to mobile phone
production and 60% to boat production. What is the pre-specialization output of mobile
phones and boats? Write your answers in Table 2.3 below.
-

In each country before specialization, 400 workers will be producing MP and

600 will be producing B.
Table 2.3: Production and Consumption before Specialization
Finland

Mobile phones
400 32 = 12,800

Boats
600 4 = 2,400

Canada

400 40 = 16,000

600 10 = 6,000

Total

28,800

8,400

E. Suppose each country specializes in the production of the good in which it has a
comparative advantage. Complete Table 2.4 below.
-

Finland will specialize in producing and exporting MP while Canada will

specialize in producing and exporting B.

Again, specialization is complete!

Table 2.4: Production after Specialization
Finland

Mobile phones
1000 32 = 32,000

Boats
0

Canada

1000 10 = 10,000

Total

32,000

10,000

Total Gains from Specialization 32,000 28,800 = +3,200 10,000 8,400 = +1,600

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F. Assume that with trade, the two countries will exchange 3,000 boats for 18,000
mobile phones. Calculate consumption after trade as well as gains from trade in each
country. Use your answers to complete tables 2.5 and 2.6 below.
Table 2.5: Consumption after Trade
Finland

Mobile phones
32,000 18,000 = 14,000

Boats
0 + 3,000 = 3,000

Canada

0 + 18,000 = 18,000

10,000 3,000 = 7,000

Table 2.6: Gains from Trade

Finland

Mobile phones
14,000 12,800 = +1,200

Boats
3,000 2,400 = +600

Canada

18,000 16,000 = +2,000

7,000 6,000 = +1,000

Total

+3,200

+1,600

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