Hi all. This is my first time posting a question (relating to the CFA curriculum) on the forum. So please bear with me and correct me if i don’t provide enough details or i break the forum rules.
On page 341(CFA Institute Book on Economics) there is an example involving the U.K and India that is used to explain the concept of comparative advantage. Its a relatively easy concept but what i’m not getting is, after the U.K and India open up the economy, how is the “160 machines exported to India” figure determined? Is it an arbitrarily figure or is there a way the figure is determined? In other words, if two countries start trading, how do we determine how much is consumed domestically and how much is exported?
In the example, the u.k produces 400 machines(initially it was 200 machines and 200 yards of cloth. They stopped producing cloths which they didn’t have comparative advantage on), exports 160 of them and consumes 240. For India I’m getting where the 640 of exported yards of cloth are coming from; world price is 1M:4C(1 machine for 4 yards of cloth). So if the U.K exports 160 machines, they’ll get 640(160*4) yards of cloth from India.
The UK will not trade away so many machines that it doesn’t have enough left to satisfy domestic demand, and it won’t trade away zero. But the actual amount it does trade away can be anywhere between those extremes.
The key point is that the UK and India will trade at an exchange rate that is between the UK’s domestic cloth/machine rate and India’s domestic cloth/machine rate.
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