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 Maldonia and Desonia. Both countries produce grain and sugar, each initially (i.e., before specialization and trade) producing 18 million pounds of grain and 9 million pounds of sugar, as indicated by the grey stars marked with the letter A. Maldonia 0 6 12 18 24 30 36 42 48 48 42 36 30 24 18 12 6 0 SUGAR (Millions of pounds) GRAIN (Millions of pounds) PPF A Desonia 0 6 12 18 24 30 36 42 48 48 42 36 30 24 18 12 6 0 SUGAR (Millions of pounds) GRAIN (Millions of pounds) PPF A Maldonia has a comparative advantage in the production of , while Desonia has a comparative advantage in the production of . Suppose that Maldonia 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 grain and million pounds of sugar. Suppose that Maldonia 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 18 million pounds of grain for 18 million pounds of sugar. This ratio of goods is known as the price of trade between Maldonia and Desonia. 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. Maldonia Consumption After Trade 0 6 12 18 24 30 36 42 48 48 42 36 30 24 18 12 6 0 SUGAR (Millions of pounds) GRAIN (Millions of pounds) PPF A The following graph shows the same PPF for Desonia 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 Desonia's consumption after trade. Desonia Consumption After Trade 0 6 12 18 24 30 36 42 48 48 42 36 30 24 18 12 6 0 SUGAR (Millions of pounds) GRAIN (Millions of pounds) PPF A True or False: Without engaging in international trade, Maldonia and Desonia would not have been able to consume at the after-trade consumption bundles. (Hint: Base this question on the

Answer 1

Maldonia's opportunity cost for the production of Grain = 18/36 = 0.5 pounds of sugar.

Maldonia's opportunity cost for the production of Sugar = 36/18 = 2 pound of Potatoes.

Similarly, Desonia's opportunity cost for the production of grain = 36/24= 1.5 pound of sugar.

Desonia's opportunity cost for the production of Sugar = 24/36= 0.67 pound of potatoes

Because Maldonia has the lower opportunity in the production of Grain and Desonia has a lower opportunity cost in the production of Sugar.

This implies that Maldonia has a comparative advantage in the production of Grain , while Desonia has a comparative advantage in the production of Sugar. Suppose that both specialize in the production of the goods in which each has a comparative advantage . After specialization , the two countries can produce a total of 36 million pound of Grain (i.e only Maldonia would produce) and 36 million pound of Sugar (i.e only Desonia would produce).

Suppose that Maldonia and Desonia agree to trade. The countries decide to exchange 18 million pounds of Grain for 18 million pounds of sugar.

Then ,

		MALDONIA		DESONIA
		Grain (Millions of pounds)	Sugar (Millions of pounds)	Grain (Millions of pounds)	Sugar (Millions of pounds)
Without trade	Production and consumption	18	9	18	9
With trade	Production	36	0	0	36
	Trade	Export 18	Import 18	Import 18	Export 18
	Consumption	(36-18)=18	18	18	(36-18)=18

By plotting the after trade consumption points , we get the following graphs :

TRUE because Without engaging in international trade , Maldonia and Desonia would not have been able to consume at the after trade consumption bundles as it lies outside the PPFs.