Seamus "Skip" Cavanaugh often travels between Switzerland and Ireland. During his travels he has noticed that the two countries rarely trade with each other. He also noticed that the opportunity cost of producing a watch in Switzerland is 1/5 of a sweater and that the opportunity cost of producing a watch in Ireland is 5 sweaters. At the current time Switzerland's production is 30 sweaters and 200 watches, while Ireland's production is 200 sweaters and 30 watches.
(a) Which country has a comparative advantage in the production of which good? Explain.
(b) Describe how Skip can make a profit.
(c) Illustrate your answer to part (b) with a numerical example.

Question

Quizplus · Accepted Answer

The Answer is (a) Ireland has a comparative advantage in the production of sweaters since it has a lower opportunity cost of producing sweaters than does Switzerland (1/5 watch < 5 watches). Switzerland has a comparative advantage in the production of watches since it has a lower opportunity cost of producing watches than does Ireland (1/5 sweater < 5 sweaters).
(b) Skip can earn a profit by trading watches to Ireland for sweaters and trading sweaters to Switzerland for watches and keeping some of the items for himself.
(c) Many trading arrangements are possible here. An example: Skip says to Switzerland: produce only watches (350 of them) and give me 60 watches in return for 40 sweaters. After this trade Switzerland has 40 sweaters and 290 watches instead of the 30 sweaters and 200 watches it had before the trade. Skip says to Ireland: produce only sweaters (350 of them) and give me 60 sweaters in return for 40 watches. After this trade Ireland has 40 watches and 290 sweaters instead of the 30 watches and 200 sweaters it had before the trade. This leaves 30 watches and 30 sweaters for Skip (his profit).

Seamus "Skip" Cavanaugh Often Travels Between Switzerland and Ireland