The Gains from International Trade

The Gains from International Trade
Order 5890921
The Gains from International Trade
Question 2
a) one price; a single
b) supply; export; less than
c) demand; world; domestic
d) exports; imports; improvement
e) imports; exports
Question 4
a) Brazil has the absolute advantage in both goods because the same amount of resources
(1 million acres of land) can produce more of both goods than is possible in Mexico.
b) The country with the comparative advantage in wheat is the country that produces
wheat with the lowest opportunity cost — that is, the country that gives up the least corn
for each bushel of wheat produced. Brazil must give up 1/3 of a bushel of corn to produce
each bushel of wheat. Mexico must give up 2/5 of a bushel of corn to produce each
bushel of wheat. Since 2/5 exceeds 1/3, it is clear that Brazil has a comparative advantage
in wheat production. Using the same logic we see that Mexico has a comparative
advantage in corn production.
The Gains from International Trade
c) It is certainly possible for a country to have an absolute advantage in both goods —
this only requires that the country be more efficient than the other country in the
production of both goods. Here, by “more efficient” we mean less input per unit of
output. In this case, Brazil is more efficient in both wheat and corn and so it has the
absolute advantage in both goods. But comparative advantage is based on the idea of
opportunity cost — what must be given up in the production of one good to get more of
the other good. The opportunity cost is revealed by the slope of the production
possibilities boundary. And if a country has a lower opportunity cost for one good then it
must have a higher opportunity cost for the other good. Graphically, this simply says that
if the PPB is steeper in one country than in another with respect to one axis, then it must
be flatter in the first country than in the second with respect to the other axis.
© 2005 Pearson Education Canada Inc.
d) See the figure below. Note that each country has 1 million acres of land. So the most
wheat that Brazil could produce is 90 million bushels; the most corn it could produce
is 30 million bushels. Similarly, Mexico could never produce more than 50 million
bushels of wheat or 20 million bushels of corn.
The Gains from International Trade
e) The slope of a country’s production possibilities boundary shows the opportunity cost
in that country for each good. For example, the slope of Brazil’s PPB in the figure above
is (negative) 1/3 (note the different scales on the two axes). This is the opportunity cost of
one bushel of wheat in Brazil, meaning that Brazil must forgo 1/3 of a bushel of corn in
order to produce an extra bushel of wheat. The inverse of the slope is (negative) 3, which
is the opportunity cost of one bushel of corn in Brazil.
Question 6
a) In both markets, the absence of international trade implies that the equilibrium price will
be the one that clears the domestic market. In the figure below, these prices are denoted pC
.
© 2005 Pearson Education Canada Inc.
b) Now suppose that Canada is open to world trade, and the world price of each product is
denoted pW. In the newsprint market, the world price exceeds the domestic Canadian price.
But the law of one price applies and so only the single world price applies (since Canada is
a small player in the much larger world economy). At the high world price, Canadian
producers increase their quantity supplied to Q1 and Canadian consumers reduce their
quantity demanded to Q2. The balance is exported to the rest of the world.
c) In the machinery market, the world price is less than the domestic Canadian price. But
the law of one price applies and so only the single world price applies. At the low world
price, Canadian producers reduce their quantity supplied to Q2 and Canadian consumers
increase their quantity demanded to Q1. The balance is imported from the rest of the world.
Question 8
a) The damage of Brazil’s coffee crop will lead to an increase in the world price of coffee.
Coffee is an imported good for Canada, and thus this shock leads to a terms-of-trade
deterioration for Canada.
b) The OPEC output restriction will lead to an increase in the world price of oil. Canada
produces and exports oil, but it also imports oil. However, Canada is a net exporter of oil
and so the rise in the price of oil should have a larger effect on Canada’s export price index
than on its import price index. Thus Canada’s terms of trade should improve.
c) The development of copper mines in Chile will reduce the world price of copper. Canada
is a net exporter of copper and so this will lead to a deterioration of Canada’s terms of
trade.
d) The Asian recession leads to a reduction in pork demand and thus to a reduction in the
world price of pork. Pork is an important Canadian export, so the decline in its price is a
terms-of-trade deterioration for Canada.
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