Question

Does trade between the United States and Vietnam make the countries better off or worse off?

Imagine the USA can make 4,000,000 cars, 1,000,000 textiles, or some combination of the two, while Vietnam can make 150,000 cars, 950,000 textiles, or some combination of the two. Draw and label PPFs, calculate opportunity costs and label specialization as points A, and state and label an efficient, mutually beneficial trade as points B.

Answer 1

USA = 4,000,000 cars or 1,000,000 textiles, or a combination of both .

Vietnam = 150,000 cars or 950,000 textiles, or a combination of both.

Take a look at fig 1 and 2 to see the PPF's of USA and Vietnam. Let U and V be two points on their PPF which they produce and consume before specialization and trade. U = 2000,000 cars and 500,000 textiles, V = 75,000 cars and 450,000 textiles.

Without trade, countries produce and consume at a point on their PPF's. The slope of the PPF gives the opportunity cost.

Opportunity costs is the value that is given up by producing one extra unit of the other good, as every increase in car production will imply a decrease in the textile production and vice versa.

So, for US: It can produce 4,000,000 cars OR 1,000,000 textiles,

So, opportunity cost of producing 1 car = loss of 1,000,000/4,000,000 = 1/4 textile

that US could otherwise have produced.

Similarly, to produce 1 more textile, it has to give up 4 cars, i.e. the opportunity cost of producing textile.

Similarly for Vietnam: it can produce 150,000 cars OR 950,000 textiles,

opportunity cost of producing 1 car = loss of 950,000/150,000 = 19/3 textiles

that Vietnam could otherwise have produced.

Similarly, to produce 1 more textile, it has to give up 3/19 cars, i.e. the opportunity cost of producing textile.

So, if we look at the opportunity costs in a table:

	Opp cost of one unit of car in terms of textile	Opp cost of one unit of textile in terms of car
US	1/4	4
Vietnam	19/3	3/19

Now, since US ha a lesser opportunity cost for producing cars, it has a comparative advantage in producing cars.

Vietnam has a lesser opportunity cost for producing textiles, so it has a comparative advantage in producing textiles.

Now, specialization implies to when a country shifts its resources to focus on the production of goods that offer a comparative advantage.

So, in this case , US will specialize in producing cars while Vietnam will specialize in producing textiles.

So, now, US will produce more cars and lesser textiles than before. And Vietnam will produce more textiles and lesser cars than before. These are represented by point A on Fig 3 and Fig 4. So, after specialization, US produces 3000,000 cars and 250,000 textiles. And Vietnam produces 32,500 cars and 750,000 textiles.

So, before specialization: Total production of cars in US and Vietnam = 2000,000 + 75,000 = 2,07,000

After specialization: Total production of cars = 3000,000 + 32,500 = 3,032,500

before specialization: Total production of textiles in US and Vietnam = 500,000 + 450,000 = 950,000

After specialization: Total production of textiles = 250,000 + 750,000 = 1,000,000

So, wee see with specialization. total output increases in both case of cars and textiles.

So, with trade, US will export cars and import textiles while Vietnam will export textiles and import cars.

So before trade, US produces and consumes 2000,000 cars and 500,000 textiles, after specialization US 3000,000 cars but only 250,000 textiles, so if US can export no more than (3000,000-2000,000) =1000,000 cars in exchange for imports of at least (500,000-250,000) = 250,000 textiles, it will gain from trade.

Also, if Vietnam can export no more than (750,000-450,000) = 300,000 textiles and import at least (75,000-32,500) = 42,500 cars, it will be better off.

So, for any value within this range, suppose US exports 500,000 cars, and imports 275,000 textiles from Vietnam and Vietnam exports 275,000 textiles and imports 500,000 cars from US, both countries would be able to consume a greater quantity of both goods than without trade and thus, be on a higher PPF. This can be seen in fig 3 and 4. So, both countries will mutually benefit from trade. So, it makes both the countries better off.