Define absolute advantage and comparative advantage and explain how it applies in this example

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Question 1: Absolute and Comparative Advantage

Assume a world of two nations USA and Australia.The two nations produce machinery and agriculture. The USA can produce 160 units of machinery or 200 units of agriculture while Australia can produce 140 units of machinery or 50 units of agriculture, in the same time period.

Define "absolute advantage"

Absolute advantage can be described as an economic concept used in international trade where one country has clear superior capability of production runs than another.

Question 2: The Standard Model

The Standard Model of Trade is a general model that accommodates other models which reference specific sources of comparative advantage, e.g. Ricardian model (differences in labour effectiveness) and Heckscher-Ohlin model (references ‘factors of production').

There are four key relationships upon which the Standard Model is based. Please list each of the four relationships and give one example for each.

The standard trade model is based on the following four core relationships

1. Relationship between the relative supply and production possibilities - a rise in the relative prices of a product causes the economy to produce more of that product and less of the other. Hence we can say that if there are two products a nation can produce, there would be a rise in the relative supply of one product if it's relative prices inflate

2. Relationship between relative prices and demand cash any increase in the relative price of a product would cause escalation in the relative production of that product. This is also accompanied with an adverse change in the relative consumption of the same product.

3. Relationship between the welfare effect in terms of trade - if an economy is an exporter of product a instead of product be, the direction may be reversed of this effect. This implies that any rise in trade terms would cause an escalation in the welfare of the nation and vice versa.

4. Determining the world Equilibrium with the intersection of the relative demand and relative supply curves.

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