Question

4. Specialization and trade

When a country has a comparative advantage in the production of a good, it means that it can produce this good at a lower opportunity cost than its trading partner. Then the country will specialize in the production of this good and trade it for other goods.

The following graphs show the production possibilities frontiers (PPFs) for Freedonia and Desonia. Both countries produce grain and sugar, each initially (i.e., before specialization and trade) producing 12 million pounds of grain and 6 million pounds of sugar, as indicated by the grey stars marked with the letter A.

Freedonia has a comparative advantage in the production of _______  , while Desonia has a comparative advantage in the production of _______ . Suppose that Freedonia and Desonia specialize in the production of the goods in which each has a comparative advantage. After specialization, the two countries can produce a total of_______  million pounds of sugar and _______ million pounds of grain.

Suppose that Freedonia and Desonia agree to trade. Each country focuses its resources on producing only the good in which it has a comparative advantage. The countries decide to exchange 4 million pounds of grain for 4 million pounds of sugar. This ratio of goods is known as the price of trade between Freedonia and Desonia.

The following graph shows the same PPF for Freedonia as before, as well as its initial consumption at point A. Place a black point (plus symbol) on the graph to indicate Freedonia's consumption after trade.

Note: Dashed drop lines will automatically extend to both axes.

The following graph shows the same PPF for Desonia as before, as well as its initial consumption at point A.

As you did for Freedonia, place a black point (plus symbol) on the following graph to indicate Desonia's consumption after trade. 

True or False: Without engaging in international trade, Freedonia and Desonia would not have been able to consume at the after-trade consumption bundles. (Hint: Base this question on the answers you previously entered on this page.)

• True

• False

Answer 1

(a) We first compute Opportunity Cost (OC).

In Freedonia,

OC of Sugar = 16/24 = 0.67 Grain

OC of Grain = 24/16 = 1.5 Sugar

In Desonia,

OC of Sugar = 24/12 = 2 Grain

OC of Grain = 12/24 = 0.5 Sugar

Since Freedonia can produce Sugar at a lower OC than Desonia can (0.67 < 2), Freedonia has comparative advantage in Sugar. Since Desonia can produce Grain at a lower OC than Freedonia can (0.5 < 1.5), Desonia has comparative advantage in Grain.

(b) After specialization, Freedonia produces only Sugar and Desonia produes only Grain.

Total Sugar produced = 24 million

Total Grain produced = 24 million

(c) Freedonia exports 4 million Sugar and imports 4 million Grain. Desonia exports 4 million Poatato and imports 4 million Sugar.

For Freedonia,

Consumption before trade = 6 million Sugar + 12 million Grain

Consumption after trade = 20 million Sugar (= 24 produced - 4 exported) + 16 million Grain (12 consumed before trade + 4 imported)

For Desonia,

Consumption before trade = 6 million Sugar + 12 million Grain

Consumption after trade = 10 million Sugar (= 6 consumed before trade + 4 imported) + 20 million Grain (24 produced - 4 exported)

Desonia 32 T 28 Consumption After Tra 24 20 16 12 16 20 24 28 32 GRAIN (Millions of pounds)

(d) TRUE

As seen from above graphs, the consumption bundles attained after trade lie outside the PPF for both countries, so they could not be attained before trade.