1. Gains to Trade

2. Two country model with constant costs Assume just two products and two countries. With constant costs, the PPCs are straight lines (first unit has same cost as last unit). Cost of each good is measured by the slope of the PPC in that country.

3. PPC for US

4. Opportunity cost in US For each unit of Beer that is produced, the US must give up one unit of Wine: 1B=1W. For each unit of Wine that is produced, the US must give up one unit of Beer: 1W=1B.

5. US outcome w/o trade One possible point on the US PPC is 100W and 100B. The US would only be at that specific point if its consumers valued Beer and Wine equally.

6. US outcome w/o trade

7. PPC for UK

8. Opportunity cost in UK For each unit of Beer that is produced, the UK must give up one third of a unit of Wine: 1B=1/3W. For each unit of Wine that is produced, the UK must give up three units of Beer: 1W=3B.

9. Outcome in UK w/o trade One possible point on the UK PPC is 150B and 50W.

10. UK outcome w/o trade

11. Comparative advantage The cost of producing one unit of Beer equals one unit of Wine in the US and one third unit of Wine in the UK, so UK has the comparative advantage in Beer. The cost of producing one unit of Wine equals one unit of Beer in the US and three units of Beer in the UK, so US has the comparative advantage in Wine.

12. Comparative Advantage Cost per case of Beer Cost per case of Wine US UK 1 case of Wine 1 case of Beer 1/3 case of Wine 3 cases of Beer

13. Prices w/o trade Without trade, relative prices in each country will be based on the costs of production. If producing a case of Wine requires three times the amount of resources as a case of Beer (as in the UK), the price of Wine will be three times higher than the price of Beer.

14. Prices w/o trade Price of BeerPrice of Wine US UK $10 £2£6

15. Profiting from trade Buy a case of Wine in the US for $10 Export the Wine to the UK and sell for £6 Use the £6 to buy three cases of Beer Import the Beer to the US and sell for $30

16. Specialization & Trade US specializes in Wine and trades some of it with UK for Beer. UK specializes in Beer and trades some of it with the US for Wine. Terms of trade will be between the ratios in each country before trade. In this case, 1W=2B is between 1W=1B (in US) and 1W=3B (in UK).

17. Outcome with trade at one Wine for two Beer

18. US before & after trade Before trade, the US produced and consumed 100W and 100B. After trade, the US produces 200W and 0B, but consumes 150W and 125B. With trade, US consumes more of both Beer and Wine.

19. UK before & after trade Before trade, the UK produced and consumed 150B and 50W. After trade, the UK produced 300B and 0W, but consumed 200B and 50W. With trade, the UK consumes the same amount of Wine and more Beer.