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

Two economies each have 100 worker-days. Economy X makes 5 units of insurance software or 10 units of hardware per worker-day. Economy Y makes 2 units of software or 8 units of hardware. Which statement about comparative advantage is correct?

X has a comparative advantage in software, since its opportunity cost is 2 hardware per software against Y's 4. The lower opportunity cost decides comparative advantage, regardless of X being more productive in both goods in absolute terms.

  1. AX has a comparative advantage in hardware because its absolute output of hardware is higher
  2. BY has a comparative advantage in software because its opportunity cost of software is 4 hardware
  3. CX has a comparative advantage in software because its opportunity cost of software is 2 hardware, against 4 for YCorrect
  4. DY has a comparative advantage in hardware because its opportunity cost of hardware is 0.5 software
  5. Neither has a comparative advantage because X is more productive in both

Explanation

X gives up 10/5 = 2 hardware per software; Y gives up 8/2 = 4 hardware. X's cost is lower, so X has the comparative advantage in software. Y's hardware cost is 2/8 = 0.25 software versus X's 0.5, so Y holds it in hardware. Absolute productivity does not decide this.

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