1. Comparative Advantage and Trade

2. Comparative Advantage Between Nations: Apple Island vs Wheat Island
Production if 100% of island
resources used on one good;
Tradeoffs when both are produced
Comparative Advantage
Wheat Island (WI), inhabited by Wheaties
12.5K apples or 10K tons of wheat;
1.25 apples per ton of wheat
0.8 tons of wheat per apple
Wheat
Apple Island (AI), inhabited by Apploids
10K apples or 4K tons of wheat;
2.5 apples per ton of wheat
0.4 tons of wheat per apple
Apples

3. Feasible Production Sets in Autarky
Wheat Island (WI), inhabited by Wheaties
Apple Island (AI), inhabited by Apploids
10,000
10,000
12,500
Wheaties feasible set
Slope = -0.8 tons wheat per apple
Tons of wheat
Tons of wheat
Slope = -0.4 tons wheat per apple
4,000
Apploids feasible set
Number of apples
Number of apples
10,000

4. Production and Consumption in Autarky
12,500
5,000 E
6,000
Production and Consumption in Autarky
10,000
Number of apples
Tons of wheat
4,000
2,500 D
3,750
Apploids’ indifference
curves
Wheat Island (WI), inhabited by Wheaties
Apple Island (AI), inhabited by Apploids
10,000
Wheaties’ indifference
curves
Tons of wheat
Number of apples

5. Production and Consumption Choices in Autarky
12,500
5,000 E
6,000
10,000
Number of apples
4,000
2,500 D
3,750
Apploids’ feasible consumption frontier
Apploids’ indifference
curves
Autarky price of apples in terms of wheat:
WI: 0.8 tons of wheat
AI: 0.4 tons of wheat
Apples more expensive on WI.
If WI and AI were to trade without cost (i.e. no price gap):
AI will specialize in apples and WI in wheat.
What would be the world price of apples?
Hint: AI/WI will only export if it can get wheat/apples more cheaply than if it produced it itself.
Wheaties’ feasible
consumption frontier
10,000
Wheaties’ indifference
curves
Tons of wheat
Number of apples

6. From Autarky to Trade E and D are consumption in autarky.
World production is 8.5K tons of wheat and 8.75K apples.
With costless trade,
World production is 10K apples and 10K tons wheat.
Price of apples is between 0.4 and 0.8.
Apples cheaper than autarky in WI and more expensive in AI.
Wheat cheaper than autarky in AI and more expensive in WI.
Both AI and WI reach higher indifference curves.
10,000
Wheaties’
feasible
consumption
frontier (through trade)
5,000
12,500 B
2,000
8,000 A
6,000
4,000
Apploids’
feasible
consumption
frontier (through trade) E
6,000
Tons of wheat
4,000
10,000
Wheaties feasible production
frontier D
2,500
Apploids’
feasible
production
frontier
3,750
5,000
Number of apples

7. Comparative Advantage and Trade
With trade, AI specializes in producing apples and WI specializes in producing wheat.
Both of their consumption frontiers are above their production frontiers, so they are both better off.
The relative price of apples to wheat depends on each countries’s bargaining power and reservation option.

8. Winners and Losers: Short Run
Opening trade increases countries’ consumption possibility sets, but conflicts of interest emerge between and within countries.
Hecksher-Ohlin model suggests winners and losers from trade depend on the relative scarcity of factors e.g. skilled labor, unskilled labor, capital, land:
Relatively abundant factors within a country are relatively cheap, and gain when trade raises their price towards the world average.
Conversely, the price of relatively scarce factors falls towards the world average due to trade.
Note: price of labor is the wage; price of land is land rent; price of capital is the return to capital.