Two countries produce two different items root beer and chee

Two countries produce two different items, root beer and cheese. The table below shows the amounts of each commodity that each country can produce with 100 units of factor inputs. Consumption in each country is equal to production – that is, if trade is warranted, citizens need to receive at least as much root beer and cheese as they started with before trade. Given the following production levels, calculate the best possible trading scenario that maximizes global welfare. Remember each country has 100 productive units which they can use in any combination. Before trade, each country has allocated 50% of their productive units to each product. That is, before trade, Hokieland makes 25 gallons of root beer and 10 wheels of cheese. What should each country do if they trade? [be careful, you need to make at least as much after trade as you had before trade.] Explain your solution. Use this example to clearly explain the difference between Absolute and Comparative advantage.

Hokieland

Eagleland

Root Beer

2 units per gallon

4 units per gallon

Cheese

5 units per wheel

8 units per wheel

Solution

Each country is assigning 50% of its productive units to the two products namely Root Beer and Cheese. AS per the data given Hokieland uses 2 productive units to have one gallon of Roor Beer whereas Eagleland uses 4units and for one wheel of Cheese 5 units are consumed by Hokieland as compared to 8 units by Eagleland.

Considering both the countries as one, we get

Total production of Root Beer is = 37.5 (25+12.5)

Total production of Cheese is = 16.25 (10+6.25)

Clearly Country Hokieland has Absolute advantage over Eagleland as it produces more of both the Root Beer as well as Cheese. In other words Eagleland consumes more productive units to produce one gallon of Root Beer and on wheel of Cheese as compared to Hokieland.

Comparative advantage is with in the same country. In case of Hokieland, one wheel of Cheese uses 5 units as compared to 2 units per gallon of Root beer so Hokieland is more productive in case of Root Beer as compared to Cheese. It is also true in case of Eagleland as it requires 8 units for Cheese as compared to 4 units for Root Beer.

But ratios are different, for Hokieland it is 2/5 whereas for Eagleland it is 1/2 (4/8) therefore Hokieland has comparative advantage for production of Root Beer as it loses1/2wheels of cheese whereas Hokieland loses.4wheels of cheese for one gallon of Root Beer whereas Eagleland has compative advantage in case of Cheese because per wheel of cheese it loses 2 gallons of Root Beer whereas Hokieland loses 2.5 gallons of Root Beer for production of one wheel of cheese.

Therefore Hokieland should specialise in production of Root Beer whereas Eagleland should go far production of cheese.

At present Hokieland produces 25 gallons (50 productive units) of Root Beer and 10wheels (50productive units) of Cheese. In case these are the minimum quantities of each then we are not left with any options.