Suppose that there are two products: clothing and soda. Both Brazil and the United States produce each product. Brazil can produce 100,000 units of clothing per year and 50,000 cans of soda. The United States can produce 65,000 units of clothing per year and 250,000 cans of soda. Assume that costs remain constant. For this example, assume that the production possibility frontier (PPF) is a straight line for each country because no other data points are available or provided. Include a PPF graph for each country in your paper.
What would be the production possibility frontiers for Brazil and the United States?
Without trade, the United States produces and consumes 32,500 units of clothing and 125,000 cans of soda. Without trade, Brazil produces and consumes 50,000 units of clothing and 25,000 cans of soda. Denote these points on each country’s production possibility frontier.
Using what you have learned and any independent research you may conduct, which product should each country specialize in, and why?
Amacher & Pate (2014) tell us that PPF graphs indicate the opportunity costs between two products: if Brazil produces 100,000 units of clothing in 2016, the country forfeits 50,000 cans of soda. Hence, the Brazilian opportunity cost of 100,000 units of clothing is 50,000 cans of soda. For the U.S., the opportunity cost of 65,000 units of clothing is 250,000 cans of soda. To graph this relationship is very simple: it is a straight line connecting 100,000 units of clothing to 50,000 cans of soda for Brazil, and a straight line connecting 65,000 units of clothing to 250,000 cans of soda in the United States:
Acemoglu, Laibson, & List (2016, p. 204) posit the PPF shows the relationship between the maximum production of a given good for the level of production of a different product. In fact, we can clearly see that when Brazil produces 50,000 cans of soda, it will make zero clothing; and the country produces 100,000 units of clothing, it will not make a single can of soda. A similar conclusion is drawn with regards to the United States: if our country decides to produce 65,000 units of clothing, it will provide no soda cans. Conversely, a 250,000-can-of-soda production means not a single article of clothing will be manufactured in the United States.
A natural question arises: how much should each country produce? Referring again to the opportunity cost, if we calculate the Brazilian ratio, they can produce 2 units of clothing per each forfeited can of soda. That is the marginal rate of transformation or the rate at which one good must be forfeited to produce a single unit of the other good. For the United States, the marginal rate of transformation is 0.26 units of clothing per each can of soda (65,000 divided by 250,000). In other words, we can see that clothing is much cheaper in Brazil than in the United States.
The reason for this difference in pricing is that clothing is a labor-intensive good. The technology to produce clothes is timeworn, as modern clothing manufacturing technology dates to the Industrial Revolution of the early XIX century. Brazil is a labor-abundant country, hence labor there tends to be cheap. Countries with cheap labor (Brazil) have an advantage over countries where labor is expensive (United States) when producing this type of old-tech product. We can see that the opportunity cost of production of clothing, in Brazil, is lower than the same cost in the United States. In parallel, the marginal rate of transformation is higher for clothing vs. sodas in Brazil, as compared to the United States.
However, if we calculate the inverse ratio (soda can production divided by clothing production), the Brazilian index will be 0.5 (50,000 divided by 100,000), while the American marginal rate of transformation of sodas vs. clothing will be 3.85 (250,000 divided by 65,000). Sodas are much cheaper in the United States than in Brazil: for the opportunity cost of a single piece of clothing, an American worker produces 3.85 cans of soda, while her Brazilian colleague produces half a can.
Unlike clothing, soda cans are a capital-intensive good, since the technology to make this product involves a more developed set of technological skills: production of aluminum, sugar, gas, highly filtered water A capital-abundant country such as the United States has an advantage in the manufacture of soda cans over countries where capital is scarce – a condition shared by Brazil and many others developing nations (Case, Fair, & Oster, 2012, p. 38).
Amacher & Pate (2014) tell us that the principle of comparative advantage states that each producer (an individual, group of people, or even country) ought to specialize in the service or product for which its opportunity cost of production is lowest. In fact, if each country entirely specializes its output, Brazil will produce 100,000 units of clothing and the United States will produce 250,000 soda cans. Their combined consumption of clothing is 82,5000 units (32,500 + 50,000) and of soda is 150,000 (125,000 + 25,000). The individual production of Brazil generates a surplus of 17,500 units of clothing, and that of the United States offers 50,000 soda cans above demand. Had they opted for internal production of both goods, they would be consuming much less (as it can be seen in the graph). In other words, both countries are better off – they even generate a surplus – if they stick to their competitive advantages and freely trade their goods. This simple example confirms the suggestion of Mankiw (2012a), who defended that specialization and free trade are good and interdependence of nations is a desirable result (p. 58).
In fact, many economists posit that trade is an essential tool to reduce poverty in developing countries. Mankiw (2012b) states that “economists view the United States as an ongoing experiment that confirms the virtues of free trade” (p. 188). The author mentions that, during its history, the United States has permitted free trade across state borders, allowing the country to benefit greatly from the specialization of commerce. Mankiw (2012b) gives the example of Floridian oranges, Alaskan oil, and Californian wine to assert that the current American standard of living is much higher than if each state had to produce its own goods (p. 188). In fact, it is easy to see that it would be nearly impossible to have Alaskan oranges or Floridian oil. The author finally suggests that the world could similarly benefit from free trade among the many nations.
References
Acemoglu, D., Laibson, D. I., & List, J. A. (2016). Microeconomics. Boston, Mass.: Pearson
Amacher, R., & Pate, J. (2014). Principles of Microeconomics. Available from
https://itunes.apple.com/us/book/principles-microeconomics/id892564869?mt=13
Prentice Hall.
Mankiw, N. G. (2012a). Essentials of Economics. Mason, OH: South-Western Cengage
Learning.
Mankiw, N. G. (2012b). Principles of Microeconomics (6th ed.). Mason, OH: South-Western
Cengage Learning.
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