INTERNATIONAL_TRADE_THEORY

Us japan food clothing food 30 60 90f 30c 60f 60c 3f

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U.S. Japan Food Clothing Food Clothing 90 0 60 0 0 30 0 60 90F = 30C 60F = 60C 3F = 1C 1F = 1C U.S specializes in producing food and Japan in producing clothing c) The Terms of Trade: 2F = 1C Clothing Food 30 0 10 20 30 60 90 A B C D United States Clothing Food 20 0 20 40 60 40 60 A B C D Japan
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Now the U.S. produces 90 units of food and trades (exports) 20 units to Japan, for which it receives in exchange (imports) 10 units of clothing. Thus, the U.S consumes 10 units of clothing plus 70 units of food it has left over. After specialization and trade: U.S. = 70F & 10C Japan = 20F & 50C Comparing the consumption levels of both countries in the no specialization – no trade case with the specialization – trade case, we find that both countries consume more in the specialization – trade case. The U.S. consumes 10 more units of food and no less clothing. Japan consumes 10 more units of clothing and no less food. Both Countries have made themselves better off through specialization and trade. Comparative Advantage The situation where a country can produce a good at lower opportunity cost than another country. It has an absolute advantage in the production of both goods. U.S. Japan Food Clothing Food Clothing A 90 0 A 15 0 B 60 10 B 10 5 C 30 20 C 5 10 D 0 30 D 0 15 Before Specialization The U.S is producing and consuming the combination of the two goods represented by point B on its PPF, and Japan is producing and consuming the combination of the two goods represented by the point B on its PPF. Comparative advantage stipulates that countries should specialize in the production of the good in which they have a comparative advantage. U.S Japan 1C = 3F 1C = 1F 1F = 1/3 C 1F = 1C The U.S. can produce food at a lower opportunity cost (1/3C as opposed to 1C in Japan). On the other hand, Japan can produce clothing at a lower opportunity cost (1F as opposed to 3F in the U.S). Thus, the U.S has a comparative advantage in food, and Japan has a comparative advantage in clothing. After Specialization The U.S specializes in the production of food, while Japan specializes in the production of clothing. The Terms of Trade: 2F = 1C
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After specialization, the U.S produces 9F and trades 20 units to Japan, receiving 10 units of clothing in exchange. The U.S now consumes 70F and 10C. Japan produces 15C and trades 10 units to the U.S, receiving 20 units of food in exchange. Japan now consumes 5C and 20F. Comparing the consumption levels in both countries in the two cases, the U.S and Japan each consume 10 more units of food and no less clothing in the specialization – trade case than in the no specialization – no trade case. HOW DO COUNTRIES KNOW WHEN THEY HAVE A COMPARATIVE ADVANTAGE? Government officials of a country do not sit down with piles of cost data before them and determine what their country should specialize in producing and then trade. Countries do not plot PPF on graph paper or calculate opportunity costs. Instead, it is individuals’ desire to make a dollar, a franc, or a pound that determines the pattern of international
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