Chapter 30-Specialization and Trade II

1) Trade possibilities curves provide an alternative way of solving output problems
       a) The trade possibilities curve (TPC) shows the amount of two items a country can obtain by specializing in one and trading for the other
           i) The production possibilities curve (PPC) assumes a closed economy where trade-offs must be made in how a nation uses its own resources
          ii) The TPC assumes an open economy where a nation is free to specialize its own production and trade with other nations
      b) Comparing the TPCs of different economies reveals their absolute and comparative advantage
           i) The slope of the trade possibilities curve, which may be found using the slope formula (y1-y0)/(x1-x0), provides the opportunity cost of producing one more unit of a particular good.

Examples (Note: Use the absolute values to simplify the comparisons)

Opportunity cost of good X for TCP1 = (30-0) / (0-25) = |6/5|

Opportunity cost of good X for TCP2 = (50-0) / (0-50) = |1|

Opportunity cost of good Y for TPC1 = (25-0) / (0-30) = |5/6|

Opportunity cost of good Y for TCP2 = (50-0) / (0-50) = |1|

            ii) The nation with the lower opportunity cost has a comparative advantage in that particular item-in the above example, though nation 2 has the absolute advantage in producing both goods, nation 2 has a comparative advantage in producing good X (1<6/5) while nation 1 has the comparative advantage in producing good Y (5/6<1)

 2. Rules of specialization-these hold true for both input and output problems 

        a) In general, producers should specialize in making a product only when their cost ratio of doing so is less than that of their trading partners

        b) The no advantage rule states that nations should not specialize or trade if neither trading partner possesses a cost advantage in producing either product

• Though Funkytown produces greater total output, neither has an advantage when cost ratios are compared

         c) The absolute advantage rule (Adam Smith) states that two countries should specialize and trade when each partner has an output advantage over the other

• This rule isn't always a reliable guide because having an output advantage doesn't guarantee a cost advantage (in terms of cost ratios)

           d) The comparative advantage rule (David Ricardo) states that two countries should specialize and trade, even if one produces more output of both products, as long as each partner has a cost advantage over the other

Example:

• Though Boogieland has an absolute advantage in both products, each nation still enjoys a cost advantage over the other and therefore should specialize and trade