Trade Analysis Analyzing Trade Problems using a 4-step process

4-step process to solve all trade problems: 1) Construct a trade table with numerical ratios of trade-offs: Determine which country has an absolute & comparative advantage in each good Determine which country will produce which good Find the range of acceptable trade that makes each country better off. Terms of Trade Coffee 1000 1000 Coffee 500 Wheat 1000 Wheat

Set up an Opportunity Cost Table Coffee Coffee BRAZIL 1000 1000 MEXICO STEP #1 Set up an Opportunity Cost Table 1000 500 Wheat Wheat Opportunity Cost Table BRAZIL MEXICO 1 Coffee = ____ Wheat 1 Coffee = _____ Wheat 1 Wheat = ____ Coffee 1 Wheat = ____ Coffee (gain) (cost) 1 1/2 1 2

Step #3 STEP #2 Mexico produces Coffee & Brazil produces Wheat Brazil: 1000 Coffee or 1000 Wheat STEP #2 Determine who has a: ABSOLUTE/COMPARITVE ADVANTAGE Mexico 1000 Coffee or 500 Wheat BRAZIL MEXICO 1 Coffee = __1__ Wheat 1 Coffee = __1/2___ Wheat 1 Wheat = __1__ Coffee 1 Wheat = __2__ Coffee Equally efficient at Coffee Absolute Advantage Wheat Comparative Advantage Wheat Equally efficient at Coffee Comparative Advantage Coffee Step #3 Determine who will produce which good Mexico produces Coffee & Brazil produces Wheat

Ranges for Efficient Trade (Terms of Trade) Step #4 Develop Terms of Trade BRAZIL MEXICO 1 Coffee = ____Wheat 1 Coffee = _____ Wheat 1 Wheat = ____ Coffee 1 Wheat = ____Coffee Ranges for Efficient Trade (Terms of Trade) wheat 1 1/2 coffee 1 2 Wheat Trading: must be higher than the opportunity cost 300 wheat 400 coffee = .75 Mexico must buy wheat at a ratio above ½ wheat per coffee Coffee Trading: must between higher than the opportunity cost Brazil must sell Wheat at a ratio below 1 wheat per coffee 300 wheat 400 coffee = 1.33 Terms of Trade: above ½ & below 1 wheat per coffee or above 1 & below 2 coffee per wheat

Graph a beneficial Trade Graphing Trade Graph a beneficial Trade BRAZIL MEXICO Coffee 1000 1000 .(300, 600) after trade Coffee .(700, 400) * (500,500) after trade * (250,500) 500 Wheat 1000 Wheat Trade Example: BRAZIL MEXICO 400 Coffee 0 Coffee 1,000 Wheat 1,000 Coffee 0 Wheat 300 Wheat