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

Country A can produce either 10 units of cloth or 5 units of wheat per worker-day. Country B can produce either 6 units of cloth or 4 units of wheat per worker-day. Which statement about gains from specialisation and trade is correct?

Country A has a comparative advantage in cloth and Country B in wheat, because opportunity costs differ: cloth costs A 0.5 wheat but B 0.667 wheat. Absolute advantage in both goods does not remove the mutual gains from trade.

  1. AA has a comparative advantage in cloth and B in wheat, so both can gain from tradeCorrect
  2. BA has an absolute advantage in both goods, so no trade gains exist
  3. CB has a comparative advantage in cloth because it produces less of it
  4. DA has a comparative advantage in wheat because its output of wheat is positive
  5. B has a comparative advantage in neither good, so it cannot gain

Explanation

A's opportunity cost of 1 cloth is 0.5 wheat, while B's is 0.667 wheat, so A has the lower cost in cloth. For wheat, A gives up 2 cloth while B gives up 1.5 cloth, so B has the lower cost in wheat. Differing opportunity costs create mutual gains despite A's absolute advantage in both.

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