Answer
a. Without trade, the price of a pair of white socks in Boston is 1 pair of red socks. The price of one pair white socks in Chicago is 2 pairs of red socks.
b. Boston has the absolute advantage of Red Socks and White Socks. Boston also has the comparative advantage in White Socks, but Chicago has the comparative advantage in Red Socks.
c. Based on their comparative advantages Chicago will export Red Socks and Boston will export White Socks.
d. Chicago will export and Boston will import Red Socks for a relative price per pair from 0.5 to 1 pair of White Socks.
Boston will export and Chicago will import White Socks for a relative price per pair from 1 to 2 pairs of Red Socks.
Work Step by Step
a. To answer this the price of white socks has to be described in relation to red socks: How many pairs of red socks can be produced instead of one pair of white socks? Boston can produce 3 pairs of socks per hour, red or white ones. Therefore the relation is 1:1: One pair of white socks costs one pair of red socks.
Chicago can only produce 2 pairs of red socks or one pair of white socks per hour. The relation is 2:1. Therefore one pair of white socks costs 2 pairs of red socks.
b. The city which produces more pairs of socks of a certain colour per hour has the absolute advantage. In one hour Boston produces 3 pairs of red socks, Chicago only 2. Boston has the absolute advantage in red socks.
In one hour Boston produces 3 pairs of white socks, Chicago produces only 1 pair in one hour. Boston has the absolute advantage in white socks.
The city which has lower opportunity costs in producing a pair of socks of a certain colour has a comparative advantage. Opportunity costs describe what they have to give up to do something.
To produce 1 pair of white socks Boston has to give up on producing 1 pair of red socks. Chicago has to give up the production of 2 pairs of red socks to produce 1 pair of white socks. Boston has the lower opportunity cost and therefore the comparative advantage in producing white socks.
To produce 1 pair of red socks Boston has to give up on producing 1 pair of white socks. Chicago has to give up the production of 0.5 pairs of white socks to produce one pair of red socks. Chicago has the lower opportunity costs and therefore the comparative advantage in producing red socks.
c. The cities will trade red and white socks with each other because each of them has the comparative advantage in producing one colour of socks. A city will export the socks they have the comparative advantage of producing them. Therefore Boston will export white socks, while Chicago will export red socks.
d. The maximum price for a red (or white) pair of socks is the price the importing city could produce it on its own for. The minimum price of a red (or white) pair of socks is the price the exporting city produces it for.
Chicago produces red socks for a relative price per pair of 0.5 pair of white socks, this will be the minimum price of a pair of red socks. Boston could produce a pair of red socks for 1 pair of white socks, therefore this will be the maximum price for a pair of red socks. Chicago will export and Boston will import Red Socks for a relative price per pair from 0.5 to 1 pair of White Socks.
Boston produces white socks for a relative price per pair of 1 pair of red socks, this will be the minimum price of a pair of white socks. Chicago could produce a pair or white socks for 2 pairs of red socks, therefore this will be the maximum price for a pair of red socks. Boston will export and Chicago will import White Socks for a relative price per pair from 1 to 2 pairs of Red Socks.
