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

India can produce either 10 tonnes of textiles or 5 tonnes of machinery with its resources in a given period, while Vietnam can produce either 8 tonnes of textiles or 2 tonnes of machinery. Which statement about comparative advantage is correct?

India has the comparative advantage in machinery because giving up 2 tonnes of textiles per tonne of machinery is cheaper than Vietnam's 4 tonnes. Vietnam therefore has the comparative advantage in textiles. Comparative advantage depends on opportunity cost, not on who produces more in absolute terms.

  1. AIndia has a comparative advantage in machinery, because its opportunity cost of machinery is 2 tonnes of textiles against 4 in VietnamCorrect
  2. BIndia has a comparative advantage in textiles, because it can produce more textiles than Vietnam
  3. CVietnam has a comparative advantage in machinery, because its opportunity cost is lower
  4. DVietnam has a comparative advantage in both goods, because its costs are lower
  5. Neither country has a comparative advantage, because India has an absolute advantage in both goods

Explanation

India's opportunity cost of 1 tonne of machinery is 10/5 = 2 tonnes of textiles; Vietnam's is 8/2 = 4. India's is lower, so India has the comparative advantage in machinery, and Vietnam in textiles (0.25 against 0.5 machinery). Absolute advantage does not decide the pattern of trade.

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