merged

Country X Productivity
Wheat -- 4 tons per hectare
Bananas -- 4 tons per hectare
Country Y Productivity
Wheat -- 2 tons per hectare
Bananas -- 60 tons per hectare
Opportunity Cost per Ton
1 ton of bananas
1 ton of wheat
Opportunity Cost per Ton
30 tons of bananas
1/30 ton of wheat
Example 3A: Assume that Country X and Country Y do not trade with each other. Rather, each
country produces both wheat and bananas. Each country uses half of its land (500 hectares) to
produce wheat and half (500 hectares) to produce bananas. Country X will be able to produce
2,000 tons of wheat (500 hectares x 4 tons of wheat per hectare) and 2,000 tons of bananas (500
hectares x 4 tons of bananas per hectare). Country Y will be able to produce 1,000 tons of wheat
(500 acres x 2 tons of wheat per hectare) and 30,000 tons of bananas (500 hectares x 60 tons of
bananas per hectare). Total production for the two countries combined is 3,000 tons of wheat and
32,000 tons of bananas.
Example 3B: Assume that Country X and Country Y produce and trade according to comparative
advantage. Country X uses all 1,000 hectares of land to produce wheat, producing 4,000 tons of
wheat (1,000 hectares x 4 tons of wheat per hectare). Country Y uses all 1,000 hectares to
produce bananas, producing 60,000 tons of bananas (1,000 hectares x 60 tons of bananas per
hectare). By producing according to comparative advantage, the output produced by the two
countries combined has been increased, as detailed on the table:
Tons of Production without Trade Tons of Production with Trade
Wheat Bananas Wheat Bananas
Country X 2,000 2,000 4,000 0
Country Y 1,000 30,000 0 60,000
Total 3,000 32,000 4,000 60,000
The examples above show that both countries can benefit from specialization and trade
according to comparative advantage. The specialization according to comparative advantage
causes resources to be allocated to their most productive uses. This allows for more production
from the same amount of resources, and is a type of technological advance.
But how do countries determine where their comparative advantage lies? Do the governments of
Country X and Country Y need to carefully study opportunity cost and direct production
accordingly? No. In a free market, profit-seeking will lead to production and trade according to
comparative advantage.
Profit-seeking producers in Country X will discover that producing wheat is profitable (they can
produce at a lower opportunity cost than producers in Country Y) and that producing bananas is
unprofitable. Thus, they will specialize in wheat production. Profit-seeking producers in Country Y
will discover that producing bananas is profitable and that producing wheat is unprofitable. Thus,
they will specialize in banana production.
FOR REVIEW ONLY - NOT FOR DISTRIBUTION
And what role will the governments of Country X and Country Y need to play to ensure that trade
follows comparative advantage? Simply allow free trade. Don’t interfere with the competitive
markets. In other words, do nothing.
International Trade 16 - 2