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: 2)Determine which country has an absolute & comparative advantage in each good 3)Determine which country will produce which good 4)Find the range of acceptable trade that makes each country better off. Terms of Trade Wheat Coffee Wheat

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

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

Ranges for Efficient Trade (Terms of Trade) BRAZIL MEXICO 1 Coffee = ____Wheat 1 Coffee = _____ Wheat 1 Wheat = ____ Coffee 1 Wheat = ____Coffee 1/ Mexico must buy wheat at a ratio above ½ wheat per coffee Mexico Buying Wheat: must be higher ratio than opportunity cost of making coffee Brazil must sell wheat at a ratio below 1 wheat per coffee Brazil Buying Coffee : must buy coffee lower than the opportunity cost of making wheat coffee wheat Step #4 Develop Terms of Trade Terms of Trade: Wheat: above ½ & below 1 wheat per coffee ½ < X < 1 or Coffee: above 1 & below 2 coffee per wheat 1 < X < 2

BRAZIL MEXICO Wheat Coffee Wheat * (500,500) * (250,500) 400 Coffee 300 Wheat BRAZIL 0 Coffee 1,000 Wheat 1,000 Coffee 0 Wheat MEXICO. (700, 400). (300, 600) after trade Trade Example: Graphing Trade Graph a beneficial Trade Terms of trade are ½ < X < 1 wheat per coffee So 300 wheat to 400 coffee is.75 => works for both countries!