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IAI Actuarial Core Principles · Business Economics · Globalisation and multinational business

Country A can produce 10 units of cloth or 5 units of software per worker-day. Country B can produce 6 units of cloth or 4 units of software per worker-day. Trade based on comparative advantage, which is a classic driver of globalisation, implies which of the following?

A should specialise in cloth. Its opportunity cost of one cloth unit is 0.5 software, lower than B's 0.67 (4/6). Comparative advantage, not absolute advantage, determines specialisation, so B should specialise in software and both gain from trade.

  1. AA should specialise in software because it has an absolute advantage in both goods, so B should produce nothing
  2. BB should specialise in cloth because its opportunity cost of cloth is lower than A's
  3. CA should specialise in cloth and B in software, because A has an absolute advantage in cloth
  4. DA should specialise in cloth because its opportunity cost of cloth is 0.5 software, against 0.67 for BCorrect
  5. No trade is beneficial because A is more productive in both goods

Explanation

Opportunity cost of one cloth: A = 5/10 = 0.5 software; B = 4/6 = 0.67 software. A has the lower opportunity cost in cloth, so A has the comparative advantage in cloth and B in software. Option B reverses this; absolute advantage alone does not decide specialisation.

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