Figure 4.3

10. In your answer to this question, use a diagram like Figure 4.3 and start from a notrade point like SO with a no-trade price ratio of 2 W/C. Now trade is opened and the country can trade whatever it wants at an international price ratio of 1 W/C. (In your answers, you will need to picture additional community indifference curves that exist but are not shown explicitly in Figure 4.3.) a. Show that the country can gain from trade even if the country does not change its production point. (Production stays at point SO.) (Him: The price line with slope of 1 will go through point So but will not be tangent to the productionpossibility curve.) 19. Show that the country can gain even more from trade if it also adjusts the produc tion point to its optimal position (given the price ratio of 1). Chapter 4 Trade: Factor Availability and Factor Proportions Are Key 65 c. What happens to the volume of trade as the country's position shifts from that shown in part a to that shown in part b?Figure 4.3 summarizes information on the U.S. economy. The production capabilities of the United States are shown by the bowed-out (increasing-cost) production- possibility curve, and U.S. consumption preferences are shown by a map of commu- nity indifference curves, of which three are shown. Without Trade With no trade the United States must be self-sufficient and must find the combination of domestically produced wheat and cloth that will maximize community well-being. In this case, I is the best (highest) indifference curve that the United States can achieve. To reach / , the United States must produce at S, on its production-possibility curve. At this tangent point, the United States produces and consumes 40 billion units 54 Part One The Theory of International Trade FIGURE 4.3 Indifference Wheat Curves and (billions of units per year) Production Possibilities without Trade 80 31 50 20 40 Cloth (billions of units per year) Price ratio = 2 WIC Without trade, the best an economy can do is to move to the production point that touches the highest community indifference curve. This best no-trade point is $, where the nation both produces and consumes, reaching indifference curve /,-Figure 4.3 summarizes information on the U.S. economy. The production capabilities of the United States are shown by the bowed-out (increasing-cost) production- possibility curve, and U.S. consumption preferences are shown by a map of commu- nity indifference curves, of which three are shown. Without Trade With no trade the United States must be self-sufficient and must find the combination of domestically produced wheat and cloth that will maximize community well-being. In this case, I is the best (highest) indifference curve that the United States can achieve. To reach / , the United States must produce at S, on its production-possibility curve. At this tangent point, the United States produces and consumes 40 billion units 54 Part One The Theory of International Trade FIGURE 4.3 Indifference Wheat Curves and (billions of units per year) Production Possibilities without Trade 80 31 50 20 40 Cloth (billions of units per year) Price ratio = 2 WIC Without trade, the best an economy can do is to move to the production point that touches the highest community indifference curve. This best no-trade point is $, where the nation both produces and consumes, reaching indifference curve /,-of cloth and ll billion units of wheat. The relative price of cloth in the United States with no trade is 2 WC. Point 30 is the no-trade equilibrium for the United States. If, instead, the United States found itself at any other point on the LLS. production-possibility curve, consum- ers or puoducea's would want to shift toward 50' To see this, consider the example in which the economy begins at 5,, with a price ratio set by the slope of the ppc [a relative price of l WEE}. Consumers would nd that this makes cloth look so cheap that they would rather buy more cloth than 2.0 billion units and less wheat than Ell billion units. Producers will follow this change in demand and shift resources into cloth produc- tion and out of wheat. The tendency to alter production will persist until the economy produces and consumes at $0. the Ito-trade [or autarky] equilibrium