Specialization & Comparative Advantage

Situation

Wakanda is a large island that is distant to the mainland and located at the bottom part of the Indian Ocean. Previously, due to the lack of foreign interaction, all the island residents shared the same culture, language and belief. However, after a visit from an outsider, a new belief was introduced to Wakanda. Furthermore, it started to bring conflicts to the island as the new belief was against the local culture. The disagreement between the conservative and the reformist caused Wakanda to separate to North Zimba and South Zimba.

Both countries share a similar climate, but the terrain is different. The land in the north is mostly mountainous while the south is plain. However, agriculture is important to both. Rice and beer are the most demanded products in Wakanda because they are consumed the most. The monthly average production and consumption of North Zimba is 12,000 kilograms of rice and 3,000 kegs of beer. On the other hand, South Zimba produces and consumes 26,000 kilograms of rice and 4,000 kegs of beer. If North Zimba focused on producing one good rather than both it has the potential to produce either 25,000 kilograms of rice or 6,000 kegs of beer. Likewise, for South Zimba, if it focused on one product, it has the potential to produce either 48,000 kilograms of rice or 9,000 kegs of beer. Thus, both countries decided to have a trade agreement for an effective and prospering economy. Based on the agreement they will choose one product to specialize and produce. In the event when countries fail to follow the trade agreement, both countries will remain with the status quo and will satisfy their demand through domestic production. Also, they will be reluctant to trade if both countries choose the same product to produce since there is no need to buy the same goods. Nevertheless, they will be willing to have a trade if they have an excess of different goods. Supposing that the market price for rice is two silver coins per kilogram and wine is ten silver coins per keg, and the wealth of a country can be measured by the amount they earn from trading. Then, what will North Zimba and South Zimba do? Will they trade or remain the status quo?

Analysis

Game theory is used to understand the decision-making process of North and South Zimba, and silver coins are used as a currency in the game. Given that there are three situations for each country to pick: retaining the status quo due to the failure in the trade agreement, pursuing the agreement by specializing the rice, or specializing the beer. The table below is a game theory payoff matrix from the trade between North and South Zimba. The number in the parenthesis is the revenue which they get based on their chosen and encountered situation. Basing on the potential income of the countries, South Zimba will focus on rice production and North Zimba will focus on beer production as it is their best option. By utilizing the Nash equilibrium, both countries will find the point where both benefit the most from the trade. Gains of each country is 56,000 silver coins for North Zimba and 100,000 silver coins for South Zimba. Comparing the income made by both to the status quo, South Zimba gained an additional of 8000 silver coins and North Zimba only gained 2000 silver coins.

The difference in income gained of both countries portrays the absolute advantage of South Zimba in the production of goods. It shows that South Zimba is more dominant than North Zimba as it has a stronger influence in the market. The Nash equilibrium displays the concept of comparative advantage of each country. Both countries specialize in a single good and trade with one another. With the choice of specializing, a country considers the opportunity cost of different kinds of goods and selects among choices that are most profitable. The use of comparative advantage is being able to produce goods by using fewer resources, at a lower opportunity cost. An additional quality of the game theory is that countries or firms might be forced to produce something they are not highly regarded or well-known due to the comparative advantage it gives (DanAxelsen & DanFriesner, 2006).

Works Cited

Dan, A. , & Dan, F. (2006). Using Game Theory to Teach Principles of Microeconomics. Journal for Economic Educators, 6(1).