Question

Use the Production Possibility frontier model in this question. A country produces 2 products: coffee and other stuff. Show how this country can consume more other stuff than it produces. In your answer identify imports, exports, and terms of trade.

Answer 1

Given country produces 2 goods, clothing and food. Pre trade equilibrium is shown by A where C1 units of clothing and F1 units of food are produced as well as consumed

After trade, the country having comparative advantage in food, produces more food and less clothing at B. Clothing is C2 units and food is F2 units being produced. Now the country trades F2 - F1 units (exports) with (C3 - C2) units of clothing (imports).

After trade, the country produces more food and less clothing but consumes same food units and more clothing which indicates that there are trade gains.

• Imports : Clothing (C3 - C2)
• Exports : Food (F2 - F1)
• Trade gains : Higher utility at U2 from U1.
• Terms of trade : lies between the two price lines.

Clothing C3 Trade gains C1 2 Slope -Pf/Pc C2 F1 F2 Food