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Hi Sir,
Hope you are well there.
As the topic title mentioned, the question as per below:
Unit of X/day Unit of Y/day
Country A 1,200 720
Country B 960 240
Total daily production 2,160 960As per explanation, this is related to opportunity cost.
By calculation, Country B [(1 unit of X is 240/960 = 0.25 units of Y)] is more specialise to produce unit of X as the opportunity cost is smaller than Country A [(1 unit of X is 720/1,200 = 0.6 units of Y)].
On the other hands, Country A [(1 unit of Y is 1,200/720 = 1.67 units of X)] is more specialise to produce unit of Y as the opportunity cost is smaller than Country B [(1 unit of Y is 960/240 = 4 units of X)].
By specialise the opportunity cost:
Unit of X/day Unit of Y/day
Country A 0 1,440
Country B 1,920 0
Total daily production 1,920 1,440My question stated below is when I try to understand this solution from the Study Text:
1. How to come out with the solution of specialise the opportunity cost for total daily production?
2. Based on my understanding, my solution based on my understanding, Country A is produce unit of
Y by 960 and Country B is produce unit of X by 2,160.Hope Sir can help me to solve my understanding on it.
Thank you.
Regards,
AlanThis is a very odd example for Kaplan to have in their Study Text – nothing remotely similar has ever been asked in the Paper AFM (was P4) exam (and I cannot imagine ever would be asked!!)
However have you typed out the whole question? I ask because there is no mention of either the costs or the selling prices of each product (both of which might be different in each country), and so I don’t understand how you can say anything at all about the opportunity costs of each product.
Hi Sir,
As I am reading “The Theory of Comparative Advantage” and this illustration has been used.
I will re-post the whole question below. As per your mentioned, there is no selling cost stated in the question.
_______________________________________Imagine a global economy with two countries and two products. Each country needs both products and at present all needs are met by domestic production. Each country has the same resources available to it and they are split equally between the two products.
Suppose the current situation with regard to production is as follows:
Units of X per day Units of Y per day
Country A 1,200 720
Country B 960 240
Total daily production 2,160 960As the situation currently stands, country A has an absolute advantage in production of both X and Y.
Given this what are the benefits of A trading with B?To answer this question we need to consider the opportunity costs incurred by producing X and Y.
• If country A were to focus on making X only, it would give up 720 units of Y to produce an extra 1,200 units of X, i.e. the opportunity cost of 1 unit of X is 720/1,200 = 0.6 units of Y.
• If country B were to focus on making X only, it would give up 240 units of Y to produce an extra 960 units of X, i.e. the opportunity cost of 1 unit of X is 240/960 = 0.25 units of Y.
• The opportunity cost of producing X is lower for country B than it is for country A. It follows that B has a comparative advantage in production of X and should specialise in this product.If country B is to make product X, it follows that country A should make product Y. An analysis of opportunity costs supports this conclusion.
• If country A were to focus on making Y only, it would give up 1,200 units of X to make 720 units of Y, i.e. the opportunity cost of 1 unit of Y is 1,200/720 = 1.67 units of X.
• If country B were to focus on making Y only, it would give up 960 units of X to make 240 units of Y, i.e. the opportunity cost of 1 unit of Y is 960/240 = 4 units of X.
• Since country A has the lowest opportunity cost for production of Y, it should specialise in production of this product.The impact of this decision by each country to specialise in production of the good for which they have the lowest opportunity cost on world output is shown below:
Specialisation based on lowest opportunity cost
Units of X per day Units of Y per day
Country A 0 1,440
Country B 1,920 0
Total daily production 1,920 1,440
_______________________________________These is the whole question that I copy and paste from the Study Text.
Thank you.
Regards,
AlanNow that you have added the line “Each country has the same resources available to it and they are split equally between the two products”, it makes a bit more sense.
I will try and explain in a different way.
Just suppose the limited resource was just materials, and both countries have 10,000 kgs of materials which they use 5,000 kgs for each of the two products.Country A is therefore using 5,000/1,200 = 4.16 kg per unit of X, and 5,000/720 = 6.94 kgs per unit of Y.
Country B is using 5,000/960 = 5.21 kg per unit of X, and 5,000/240 = 20.83 kgs per unit of Y.
Clearly country A is using the material more efficiently for both products, and both countries are using less material to make X than to make Y.
However if you look at the differences, B is massively less efficient making Y than making X.
(A is also less efficient making Y than making X but the difference is much, much less).It would therefore make more sense for B to switch to producing only X, and for A to switch to only producing Y. There will be an overall benefit.
I hope that helps, but as I wrote before I really do think that putting this in the study text is rather ridiculous – it is nothing like anything that is likely ever to be asked in Paper AFM. I wouldn’t spend too much time on it 🙂
Hi Sir,
Thank you for your amazing explanation!
Now, I have cleared my minds on the theory behind.
Thanks for your information about this issue (the topic will not be asked in AFM exam). As this topic still inside the Study Text, hence, I am assuming that this will be asked in the exam.
Once again, thanks for your helping on this topic.
Regards,
Alan
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