International Economics The Principle of Comparative Advantage

Assume Two Goods and Two Countries Canada with its resources can produce 50 bushels of wheat or 20 computers. US can produce 40 bushels or 80 computers.

WHEATCOMPUTERS Canada 5020 U.S. 4080

Canada’s Production Possibilities Curve Wheat Computers

U.S. Production Possibilities Curve Wheat Computers

Canada Uses ½ of its resources for each good (Point A) Wheat Computers A 10

U.S. Uses ½ of its resources for each good (Point B) Wheat Computers B 20 40

World Production of Wheat and Computers (No Specialization) WheatComputers Canada U.S World 45 50

What is Canada’s opportunity cost of producing a bushel of wheat? 2/5 of a computer What is the U.S.’s opportunity cost of producing a bushel of wheat? 2 computers Which company has a comparative advantage in the production of wheat? Canada

What is Canada’s opportunity cost of producing one computer? 5/2 bushels of wheat What is U.S.’s opportunity cost of producing one computer? ½ bushel of wheat Which company has a comparative advantage in the production of computers? The U.S. Why?

If Canada specializes in producing wheat (Point A’) Wheat Computers A’

If the U.S. specializes in producing computers (Point B’) Wheat Computers B’

World Production of Wheat and Computers (Specialization) WheatComputers Canada 50 0 U.S World World production of BOTH goods is higher under specialization.

What are the limits on the terms of trade? 1 bushel of wheat = 2/5 computers 1 bushel of wheat = 2 computers

Suppose the actual terms of trade between the two goods is 1 bushel of wheat = 1.25 computer. We can then draw the consumption possibilities curve for each country.

Canada’s Consumption Possibilities Curve (Red Line) Wheat Computers

U.S. Consumption Possibilities Curve (Red Line) Wheat Computers