Consider the following two country-two goods world, with a single input, labor:

Daily production per worker
Commodity Portugal England
Wine (barrels) 2 OR 1
Cloth (bolts) 4 OR 3

a) Does either country have absolute and/or comparative advantage in any product? Provide support for your answer by computing the “resource costs” or opportunity costs for both products in both countries.
b) Following your answer to part a, is there any advantage in trading here? At what “prices” will such trade occur? In other words, what is the maximum amount of cloth relative to wine at which trade will occur? What is the minimum amount?
c) Suppose the total cost of labor to produce daily output in each country is £20 in England, and E1600 (escudos) in Portugal. Further, let the exchange rate is £1=E50, what is the price of the goods in each country in pounds?
d) What will the exchange rate have to be to discourage Portuguese imports of British goods? Similarly, what will the exchange rate have to be to discourage British imports of Portuguese goods?

For this and your other questions, do a little research, then take a shot. What do you think? I or other will critique your answers.

a) To determine absolute and comparative advantage, we need to calculate the opportunity costs for both products in both countries.

Opportunity cost measures the trade-off between producing one good over another. It is calculated by dividing the quantity of one good foregone by the quantity of another good produced.

Opportunity cost of producing wine in Portugal:
- Portugal gives up 2 barrels of wine for every 4 bolts of cloth produced.
- Therefore, the opportunity cost of producing 1 barrel of wine in Portugal is 2/4 = 0.5 bolts of cloth.

Opportunity cost of producing wine in England:
- England gives up 1 barrel of wine for every 3 bolts of cloth produced.
- Therefore, the opportunity cost of producing 1 barrel of wine in England is 1/3 = 0.33 bolts of cloth.

Comparing the opportunity costs, we see that Portugal has a higher opportunity cost of producing wine (0.5 bolts) compared to England (0.33 bolts). Therefore, England has an absolute advantage in producing wine.

Opportunity cost of producing cloth in Portugal:
- Portugal gives up 4 bolts of cloth for every 2 barrels of wine produced.
- Therefore, the opportunity cost of producing 1 bolt of cloth in Portugal is 4/2 = 2 barrels of wine.

Opportunity cost of producing cloth in England:
- England gives up 3 bolts of cloth for every 1 barrel of wine produced.
- Therefore, the opportunity cost of producing 1 bolt of cloth in England is 3/1 = 3 barrels of wine.

Comparing the opportunity costs, we see that Portugal has a lower opportunity cost of producing cloth (2 barrels) compared to England (3 barrels). Therefore, Portugal has an absolute advantage in producing cloth.

b) Based on the absolute advantage we identified in part a, there is a potential for trade between the two countries.

To determine the trading range (the range of exchange ratios at which trade will occur) between cloth and wine, we need to compare the opportunity costs for each country.

The maximum amount of cloth relative to wine at which trade will occur is determined by comparing the opportunity costs of cloth in both countries. In this case, Portugal has a lower opportunity cost of cloth production (2 barrels) compared to England (3 barrels). Therefore, Portugal has a comparative advantage in cloth production.

The minimum amount of cloth relative to wine at which trade will occur is determined by comparing the opportunity costs of wine in both countries. In this case, England has a lower opportunity cost of wine production (0.33 bolts) compared to Portugal (0.5 bolts). Therefore, England has a comparative advantage in wine production.

Based on this, the trading range would be any exchange ratio between the opportunity costs of cloth in Portugal (2 barrels) and England (3 barrels).

c) To determine the prices of goods in each country in pounds, we need to convert the costs of labor to pounds using the given exchange rate.

Labor cost to produce daily output in England: £20
Labor cost to produce daily output in Portugal: E1600

Exchange rate: £1 = E50

Labor cost to produce daily output in Portugal in pounds:
£20 * (E1 / E50) = £0.4

Therefore, the price of goods in Portugal is £0.4.

Labor cost to produce daily output in England in pounds: £20

Therefore, the price of goods in England is £20.

d) To discourage Portuguese imports of British goods, the exchange rate needs to make British goods relatively more expensive in terms of Portuguese currency. This can be achieved by increasing the value of the pound in relation to the escudo.

Similarly, to discourage British imports of Portuguese goods, the exchange rate needs to make Portuguese goods relatively more expensive in terms of British currency. This can be achieved by decreasing the value of the pound in relation to the escudo.