The correct answer is b. Comparative advantage is determined by relative differences in labor productivity between countries. Comparative advantage is a fundamental concept in economics that explains how countries can benefit from specializing in the production of goods and services in which they have a relative efficiency or lower opportunity cost compared to other countries.

Let’s explore in detail why this answer is correct and why the other options are not suitable for describing the basis of comparative advantage.

b. Relative Differences in Labor Productivity Between Countries (Correct Answer):

1. Comparative Advantage Definition:

Comparative advantage is the ability of a country to produce a good or service at a lower opportunity cost compared to another country. Opportunity cost refers to the value of the next best alternative that must be sacrificed to produce a specific item. It is determined by the relative differences in efficiency, which include labor productivity.

2. Relative Efficiency:

Comparative advantage is not about absolute efficiency or differences in labor productivity within a country. Instead, it focuses on the relative efficiency between countries. It considers how efficiently one country can produce a particular good or service compared to another country, taking into account the trade-offs involved in using resources for one production activity over others.

3. Specialization and Trade:

When countries identify their comparative advantages, they can specialize in the production of goods and services for which they have a relative efficiency advantage. By doing so, they can trade these products with other countries, creating a situation in which both countries can benefit from access to a wider range of goods and services at a lower opportunity cost.

Now, let’s discuss why the other options are not correct:

a. Actual Differences in Labor Productivity Between Countries:

This option suggests that comparative advantage is determined by actual differences in labor productivity. However, comparative advantage is not solely based on absolute differences in productivity but rather on the relative differences in productivity.

A country may have a lower level of productivity than another in absolute terms, yet still have a comparative advantage in producing a specific good if its opportunity cost is lower relative to other goods or services.

c. Both (a) and (b):

This option combines both actual and relative differences in labor productivity. While actual differences in labor productivity can play a role in comparative advantage, the key concept is the relative difference.

A country may have higher absolute labor productivity in all industries, but it may still find it advantageous to specialize in the production of certain goods or services if it has a lower opportunity cost in those areas.

d. Neither (a) nor (b):

This option suggests that neither actual nor relative differences in labor productivity determine comparative advantage, which is not accurate. Comparative advantage is a well-established economic principle based on relative differences in efficiency and opportunity cost.

In summary, comparative advantage is determined by relative differences in labor productivity between countries. It is a concept that allows countries to identify their strengths and specialize in the production of goods and services where they have a relative efficiency advantage, leading to mutually beneficial trade relationships.

While actual productivity differences can be relevant, the core principle of comparative advantage is the relative difference in productivity and opportunity cost.