Question

4. Specialization and trade

When a country specializes in the production of a good, this means that it can produce this good at a lower opportunity cost than its trading partner. Because of this comparative advantage, both countries benefit when they specialize and trade with each other.

The following graphs show the production possibilities frontiers (PPFs) for Maldonia and Lamponia. Both countries produce potatoes and coffee, each initially (i.e., before specialization and trade) producing 18 million pounds of potatoes and 9 million pounds of coffee, as indicated by the grey stars marked with the letter A.

Maldonia has a comparative advantage in the production of ( potatoes, coffee, neither potatoes nor coffee, both potatoes and coffee) , while Lamponia has a comparative advantage in the production of ( potatoes, coffee, neither potatoes nor coffee, both potatoes and coffee). Suppose that Maldonia and Lamponia specialize in the production of the goods in which each has a comparative advantage. After specialization, the two countries can produce a total of ( what number?) million pounds of potatoes and( what number?) million pounds of coffee.

Suppose that Maldonia and Lamponia 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 12 million pounds of potatoes for 12 million pounds of coffee. This ratio of goods is known as the terms of trade between Maldonia and Lamponia.

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

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

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

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

True or False: Without engaging in international trade, Maldonia and Lamponia would 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

Answer 2