Increasing cost model

Assumptions Two countries Two products Increasing costs = the cost per unit increases as output of that good increases

Increasing costs and the bowed-out PPC

Costs and supply If the cost per unit increases as output increases, firms will only produce more if the price increases. This appears as the familiar upward sloping supply curve.

Differences in costs The cost curve for Wine may be lower in the US than the UK This means the supply curve for Wine is higher in the US than the UK The US may have more land suited for Wine, more physical capital (equipment), or more human capital (knowledge/experience)

Wine markets w/o trade

Equilibrium with Trade

Other reasons for trade Demand for a product may be higher in one country If consumers develop a taste for a particular product because it is cheap to produce in that country, they may want so much that they end up importing a large quantity.

Defining social surplus Social surplus = value – cost Consumer surplus = value – price Producer surplus = price – cost CS + PS = SS

Measuring social surplus The value of a product can be measured using the demand curve The cost of a product can be measured using the supply curve CS = area between demand curve and price PS = area between price and supply curve

Social surplus w/o trade

Social surplus w/trade

Changes in social surplus with trade In US, CS decreases by less than PS increases, so US social surplus increases In UK, CS increases by more than PS decreases, so UK social surplus increases Result = both countries gain overall, even though some people in each country lose.