2.6 Gains from Trade

Trade Example

Suppose, before trade, you choose to produce 20 pineapples and eight crabs, and Jamie decides to produce ten pineapples and nine crabs. Because you have a comparative advantage in growing pineapples, you should specialize in pineapples and can grow a maximum of 30. Jamie specializes in crabs and produces a maximum of 20 crabs. In this situation, both players produce only the goods they have the comparative advantage.

Before Trade Production Possibilities:

Fig 2.7
Pineapple Crab
You 20 8
Jamie 10 9

Exchange: If You and Jamie choose to trade ten pineapples for nine crabs, then after the trade, You are left with 20 pineapples and nine crabs (point S in Fig 2.8 Panel (A)) while Jamie is left with ten pineapples and 11 crabs (Point S1 in Fig 2.8 Panel (B)). Therefore, after the trade, You gain +1 crab, and Jamie gains +2 crabs. Both trading partners move to a point outside their current PPF, resulting in economic growth. Figure 2.8 (Panels (A) and (B)) and Fig 2.9 below show your and Jamie’s production possibilities both before and after the trade.

Yours and Jamie’s production possibilities. Point S (20,9) Point C (20,8). Point S1 (10,11) Point C1 (10,9)
Fig 2.8 – By Fanshawe College, CC BY-NC-SA 4.0
Fig 2.9 Production possibilities both before and after the trade.
You Jamie
Pineapples Crabs Pineapples Crabs
Before trade production 20 8 10 9
Specialization 30 0 0 20
After trade production and consumption 20 9 10 11
Gains from trade +1 +2

 

The implications of our model for trade are that

(a) trade is mutually beneficial

(b) certainly redistributes resources among the two trading partners

(c) leads to specialization and more significant skills.

This reallocation of resources produces enormous benefits, but they do not come without costs.

In Chapter 2, we have explored the production possibility model in-depth, looking at a simplified version of trade and deepening our understanding of opportunity costs. Now, we can take our knowledge of basic economic modelling and examine one of the most important microeconomics: supply and demand.


Attribution

2.3 Trade” in Principles of Microeconomics by Dr. Emma Hutchinson, University of Victoria is licensed under a Creative Commons Attribution 4.0 International License.

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Principles of Macroeconomics Copyright © 2023 by Sharmistha Nag is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License, except where otherwise noted.