Question

Suppose that the opportunity-cost ratio for fish and lumber is \(1 F \equiv 1 L\) in Canada but \(2 F=1 L\) in Iceland.Then ______ should specialize in producing fish while _______ should specialize in producing lumber. LO38.2 a. Canada; Iceland. b. Iceland; Canada.

Short answer

Iceland should specialize in lumber, and Canada should specialize in fish.

Step-by-step solution

Understand Opportunity Cost

Opportunity cost determines what each entity gives up to produce one unit of another good. In Canada, the opportunity cost of 1 Fish (F) is 1 Lumber (L). In Iceland, the opportunity cost of 2 Fish is 1 Lumber, meaning 1 Fish costs 0.5 Lumber.

Analyze Specialization Based on Comparative Advantage

Comparative advantage is determined by lower opportunity costs. Iceland has a lower opportunity cost for Lumber (1 Lumber costs 2 Fish) compared to Canada's 1 Fish for 1 Lumber. Therefore, Iceland should specialize where it has a comparative advantage, which is in Lumber.

Determine Specialization for Canada

Since Canada has an opportunity cost of 1 Fish for 1 Lumber, they should specialize in Fish because Iceland has a lower opportunity cost in Lumber.

Combine and Conclude

Given that Iceland should specialize in Lumber due to its lower opportunity cost, Canada should specialize in Fish to take advantage of its comparative advantage in Fish production.

Key concepts

Opportunity Cost

Opportunity cost is a key concept in economics that helps us understand the trade-offs involved in making production and consumption decisions. It refers to the value of the next best alternative that is foregone when a decision is made to produce or consume a particular good or service. This concept is crucial in assessing how resources can be best allocated across different activities.

In our exercise scenario between Canada and Iceland, opportunity cost plays a central role. For Canada, producing one unit of fish means sacrificing the production of one unit of lumber. Conversely, Iceland sacrifices only 0.5 units of lumber to produce one unit of fish. This indicates that Iceland is more efficient, or has a lower opportunity cost, in producing fish compared to Canada.

• Canada: 1 Fish costs 1 Lumber.
• Iceland: 1 Fish costs 0.5 Lumber.

This simple comparison aids in deciding who should produce what, based on who has to forego less of another commodity to produce the desired item. Understanding opportunity cost helps economic actors make informed decisions that aim to maximize their output for the resources consumed.

Specialization

Specialization refers to the process where individuals, businesses, or countries focus on producing a limited scope of goods or services to gain greater degrees of productive efficiency within an overall system. By concentrating on tasks where they have a comparative advantage, entities can produce goods and services more efficiently.

In the context of the exercise, specialization for Canada and Iceland involves focusing on producing the good for which they have a lower opportunity cost. Canada's opportunity cost for producing fish is lower compared to producing lumber when contrasted with Iceland, and vice-versa. Hence,

• Iceland should specialize in producing Lumber, as it incurs fewer lost resources compared to fish.
• Canada should focus on Fish production, leveraging their comparative efficiency.

Specialization can lead to increased total production and resource optimization as countries leverage their unique efficiencies. By specializing, both Canada and Iceland can trade and obtain more of both goods than they could on their own without specialization.

Economic Models

Economic models are simplified representations of reality that help economists understand complex economic activities, decisions, and phenomena. These models use assumptions and simplified variables to influence decision-making and predict outcomes. The concept of comparative advantage is one such model used to evaluate the benefits of specialization and trade.

Through the lens of economic models, the exercise highlights the comparative advantage model by showing how different opportunity costs dictate specialization. By using these economic models, economists can predict how two countries like Canada and Iceland can maximize their strengths in fish and lumber production, respectively. Such models help visualize the potential gains from trade and guide countries in strategic decision-making.

• This model emphasizes the importance of specialization, based on opportunity cost calculations, to enhance overall economic efficiency.
• Economic models thus play a crucial role in explaining the benefits of trade and collaborative production between economies.

Understanding and applying these models allow countries to identify potential areas for development and cooperation, thereby achieving better economic outcomes for all parties involved.