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IAI Actuarial Core Principles · Business Economics · Importance of international trade

Country A and Country B each have 120 labour hours. A needs 2 hours per unit of tea and 3 hours per unit of coffee. B needs 4 hours per unit of tea and 4 hours per unit of coffee. Each country fully specialises according to comparative advantage and they trade. What is the total combined output of the two goods after specialisation?

Combined output is 60 tea and 30 coffee. A has the lower opportunity cost in tea, so it uses its 120 hours at 2 hours per unit to make 60 tea. B specialises in coffee and makes 120 divided by 4, which is 30 units.

  1. A60 tea and 30 coffee
  2. B60 tea and 40 coffeeCorrect
  3. C30 tea and 60 coffee
  4. D60 tea and 0 coffee
  5. 40 tea and 60 coffee

Explanation

A's opportunity cost of tea is 2/3 coffee, and B's is 4/4 = 1 coffee. So A has the comparative advantage in tea and B in coffee. A specialising in tea gives 120/2 = 60 tea. B specialising in coffee gives 120/4 = 30 coffee. So total output is 60 tea and 30 coffee. Check B's cost of coffee: 1 tea, versus A's 1.5 tea, which confirms B has the advantage in coffee. Option 2 wrongly gives B 40 coffee, which uses 160 hours.

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