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

Country X can produce either 60 units of cloth or 30 units of software per worker-month. Country Y can produce either 40 units of cloth or 10 units of software per worker-month. Which statement is correct?

Y has the comparative advantage in cloth and X in software. Producing a unit of software costs X 2 cloth but Y 4 cloth, while a unit of cloth costs X 0.5 software and Y only 0.25 software. Comparative advantage depends on opportunity cost, not absolute productivity.

  1. AX has a comparative advantage in cloth and Y in software
  2. BY has a comparative advantage in cloth and X in softwareCorrect
  3. CX has an absolute advantage in cloth only
  4. DY has a comparative advantage in both goods
  5. X has a comparative advantage in neither good

Explanation

Opportunity cost of 1 software: X gives up 2 cloth; Y gives up 4 cloth. So X is cheaper in software. Opportunity cost of 1 cloth: X gives up 0.5 software; Y gives up 0.25 software, so Y is cheaper in cloth. X has absolute advantage in both goods, but comparative advantage lies with Y in cloth and X in software.

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