PROBLEM SET 2
1 - Mytown (M) and Yourtown (Y) have just opened their borders to free trade. Mytown is exporting
Laptops (L) while Yourtown exports Food (F) , then it MUST be the case that the labor requirements satisfy
(where ai,c represents the labor requirements in country c in order to produce one unit of good i.
a) aM,L > aY,L
b) aM,L < aY,L
c) aM,F > aY,F
d) aM,L/aY,L < aM,F /aY,F
a)Is incorrect because Yourtown could have an absolute advantage over Mytown but not a comparative
advantage
b)Is incorrect given the fact that Mytown could have an absolute advantage over Mytown but we do not
know about the comparative advantage
c)Is incorrect because Yourtown maybe has an absolute advantage over Mytown but not a comparative
advanatge
d)Is correct given that with this option we can compare the labor requiriments in producing Laptops between
Mytown and Yourtown and we will find the equilibrium.
2 - Northon (N) and Southon (S) have just opened their borders to free trade. Two goods are produced:
mobile phones (m) and champagne (c). The labor requirements are such that aN,m = 2aS,m and aN,c = 4aS,c
(where ai,g represents the labor requirements in country i in order to produce one unit of the good (g). From
the provided data we can deduct that:
a) Norton has an absolute advantage in the production of champagne and a comparative disadvantage in the
production of champagne. False because it has an absolute disadvantage in both goods.
b) Norton has an absolute disadvantage in the production of Mobile Phones and a comparative advantage in
mobile phones. True because
c) Southon has an absolute advantage in both goods and has a comparative advantage in mobile phones.
False, it has comparative advantage in champagne
d) None of the other.
number of workers mobiles champagne
Northon 2 4
Southon 1 1
3 - Build a numerical example with two goods (different than the one presented in the Magistral session),
where you can prove that a country that is more productive in both commodities can still benefit from trading
with a country that is less productive in all sectors. HINT: Compensate with more workers in the country
with the worst technology (next session you will understand why it is necessary to do this).
number of workers Tables Lamps
Spain 5 7
Portugal 2 4
Portugal has an absolute advantage in producing both tables and lamps and a comparative advantage in
producing Tables since it is 2.5 times more productive than Spain. However, if we only focused on lamps,
Portugal is only 1.75 times more productive than Spain, so Spain has a comparative advantage in producing
lamps
5/2 >7/4
To continue with, let's assume that Spain has 100 workers, 50 for producing tables and the other 50 produce
houses and for Portugal let’s assume that there are 60 workers, 30 for tables and 30 for houses:
Number of workers Tables Lamps
Spain 50/5=10 50/7=7,14
Portugal 30/2=15 30/4=7,5
Specialization
Tables Lamps
Spain 0/5=0 100/7=14,28
Portugal 60/2=30 0/4=0
4 - i) A country should exports the goods with low production costs and import the goods with high domestic
production costs. Is this statement true or false? (justify your answer) ii) Many people (many well known
politicians among them) believe that free trade is beneficial only if a country is strong enough to withstand
foreign competition. Do you agree with this statement
This statement is false due to the fact that trading decisions should not be made taking into account
production costs on the basis of comparative production costs. This means that when countries decide to
specialize, they should chose that good in which they have a comparative advantage, even if the production
of that good is more expensive than the production of the other one. This is also applied to imports, countries
should import those goods that they do not have the comparative advantage over.
Free trade is beneficial for every country if each country specialized in different goods and not compete
against others, It has been proved in our example in which a country that was better at producing both goods
still has benefited from trading with other country whose performance was worse at producing both goods.