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

In India, labour can make 10 metres of cloth or 5 tonnes of wheat per day; in Bangladesh, labour can make 6 metres of cloth or 4 tonnes of wheat per day. Which statement about comparative advantage is correct?

India has a comparative advantage in cloth because giving up 1 metre of cloth costs it only 0.5 tonne of wheat, against 0.67 tonne for Bangladesh. Comparative advantage depends on lower opportunity cost, not on absolute output, so an absolute advantage in both goods does not rule it out.

  1. AIndia has a comparative advantage in cloth, because its opportunity cost of 1 metre of cloth is 0.5 tonne of wheat against 0.67 tonne in BangladeshCorrect
  2. BIndia has a comparative advantage in wheat, because it produces more wheat per day than Bangladesh
  3. CBangladesh has a comparative advantage in cloth, because its opportunity cost of cloth is lower than India's
  4. DNeither country has a comparative advantage, because India has an absolute advantage in both goods
  5. Bangladesh has a comparative advantage in both goods, because its wage rates are lower

Explanation

India's opportunity cost of 1 metre of cloth is 5/10 = 0.5 tonne of wheat. Bangladesh's is 4/6 = 0.67 tonne. India's is lower, so India has the comparative advantage in cloth. Absolute advantage in both goods does not remove comparative advantage, since opportunity costs differ.

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