CA Foundation · Business Economics · International Trade
In India, 1 hour of labour produces either 6 metres of cloth or 3 kg of tea. In Sri Lanka, 1 hour produces either 2 metres of cloth or 2 kg of tea. Which statement is correct?
India has comparative advantage in cloth and Sri Lanka in tea. India gives up 0.5 kg of tea per metre of cloth against Sri Lanka's 1 kg, while Sri Lanka gives up only 1 metre of cloth per kg of tea against India's 2 metres.
- AIndia has comparative advantage in tea; Sri Lanka in cloth
- BIndia has comparative advantage in cloth; Sri Lanka in teaCorrect
- CIndia has comparative advantage in both goods
- DSri Lanka has absolute advantage in tea and cloth
Explanation
India's opportunity cost of 1 kg tea is 6/3 = 2 metres of cloth; Sri Lanka's is 2/2 = 1 metre. Tea is cheaper in Sri Lanka, so it has comparative advantage in tea. India's cost of 1 metre of cloth is 0.5 kg tea versus 1 kg in Sri Lanka, so India has comparative advantage in cloth. India also has absolute advantage in both, which is why the tempting 'both' option is wrong, since comparative advantage cannot lie in both.
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