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Countries engage in international trade for two basic reasons, each of which

contributes to their gains from trade. First, countries trade because they are

different from each other. Nations, like individuals, can benefit from their

differences by reaching an arrangement in which each does the things it does

relatively well. Second, countries trade to achieve economies of scale in

production. That is, if each country produces only a limited range of goods, it can

produce each of these goods at a larger scale and hence more efficiently than if

it tried to produce everything.

The opportunity cost of roses in terms of computers is the number of

computers that could have been produced with the resources used to produce a given

number of roses.

We therefore have an

essential insight about compa...

unit labor requirement, the number

of hours of labor required to produce

The production possibility frontier illustrates the different mixes of goods the economy can produce.

relative price of the economy’s two goods, that is, the price of one good in terms of the other.

What is the significance of the number ? We saw in the previous section that it is the opportunity cost of cheese in terms of wine. We have therefore just derived a crucial proposition about the relationship between prices and production: The economy will specialize in the production of cheese if the relative price of cheese exceeds its opportunity cost in terms of wine; it will specialize in the production of wine if the relative price of cheese is less than its opportunity cost in terms of wine.

opportunity cost equals the ratio of unit labor requirements

In the absence of international trad...

In the absence of trade, the relative prices of cheese and wine in each country would be determined by the relative unit labor requirements.

partial equilibrium analysis, that is, to study a single market

The first way to show that specialization and trade are beneficial is to think of trade as an indirect method of production.

Another way to see the mutual gains from trade is to examine how trade affects each

country’s possibilities for consumption.In each case, trade has enlarged the range of choice, and therefore it must make residents of each country better off.

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