Question

Country A and country B produce the same consumption goods and capital goods and currently have identical production possibilities curves. They also have the same resources at present, and they have access to the same technology.

a. At present, does either country have a comparative advantage in producing capital goods? Consumption goods?

b. Currently, country A has chosen to produce more consumption goods, compared with country B. Other things being equal, which country will experience the larger outward shift of its PPC during the next year?

Short answer

a. They both have the same advantage.

b. B

Step-by-step solution

Step1. Introduction

Theory of comparative advantage states that a person should engage in an economic activity which he/she has a comparative advantage in, i.e. which he/she is better off at performing than the other activity. In terms of economies, they should engage in production of those goods and services at which they are better off than the other.

Step2. Explanation

a. Two countries A and B have identical production possibility, they have the same level of resources and state of technology. This implies that both the countries A and B are at the same level in terms of production and hence no one is better off than the other in terms of production.

b. When country A will chose more consumer goods, it will remain on the same curve. In fact, chances are that country A's curve shifts inwards as the country is substituting capital goods for consumption goods. Country B, however, chooses the same combination of goods, or comparatively produces more capital goods than A, it will hence be able to produce more goods using those capital goods. So, its production possibility curve will shift outwards.