Question

The cost of producing one ton of steel in the United States is one ton less of coffee. The cost of producing one ton of steel in Brazil is foregoing two tons of coffee. Given that Brazil specializes in coffee production and the United State specializes in steel production, how will the price of steel (in terms of coffee) change in the United States? How will the price of steel change in Brazil? Generalize this result for any two nations trading on the basis of comparative advantage.

Short answer

In summary, after the United States and Brazil establish trade based on comparative advantage, the price of steel in terms of coffee will increase by 0.5 tons in the United States and decrease by 0.5 tons in Brazil. In general, when two countries trade goods based on comparative advantage, the price of the good will decrease in the country with a higher opportunity cost for producing the good and increase in the country with a lower opportunity cost, allowing both countries to benefit from trade.

Step-by-step solution

Determine the opportunity cost of steel in each country

To determine the opportunity cost of steel production in each country, we have to consider how much coffee production is given up for each ton of steel produced. For the United States: 1 ton of steel = 1 ton of coffee forgone Opportunity cost of 1 ton of steel = 1 ton of coffee For Brazil: 1 ton of steel = 2 tons of coffee forgone Opportunity cost of 1 ton of steel = 2 tons of coffee

Determine the price of steel in terms of coffee before trade

Before trade, the price of steel in each country will be equal to its opportunity cost, since there is no external influence on the price. For the United States: Price of 1 ton of steel = 1 ton of coffee For Brazil: Price of 1 ton of steel = 2 tons of coffee

Analyze the specialization and trade between the countries

As given, Brazil specializes in coffee production and the United States specializes in steel production. Since Brazil has a higher opportunity cost for producing steel, it will benefit from importing steel produced by the United States, which has a lower opportunity cost for producing steel. In return, the United States will benefit from importing coffee from Brazil, which has a lower opportunity cost for producing coffee.

Determine the price of steel in terms of coffee after trade

Once trade is established between the two countries, the price of steel in terms of coffee will converge to a range between the opportunity costs of the two countries. Let's assume that the United States is willing to trade 1 ton of steel for 1.5 tons of coffee. Therefore, the new price of steel in terms of coffee after trade will be: For the United States: Price of 1 ton of steel = 1.5 tons of coffee For Brazil: Price of 1 ton of steel = 1.5 tons of coffee

Determine the change in price of steel in terms of coffee

To determine the change in price of steel in terms of coffee, we will subtract the price before trade from the price after trade in each country. For the United States: Change in price of steel = Price after trade - Price before trade = 1.5 tons of coffee - 1 ton of coffee = 0.5 tons of coffee For Brazil: Change in price of steel = Price after trade - Price before trade = 1.5 tons of coffee - 2 tons of coffee = -0.5 tons of coffee

Generalize the result for any two countries based on comparative advantage

When two countries trade goods based on comparative advantage, the price of the good that each country specializes in will converge to a range between the opportunity costs of both countries post-trade. This means that the price of the good will decrease in the country with a higher opportunity cost for producing the good and increase in the country with a lower opportunity cost for producing the good, thus allowing both countries to benefit from trade.

Key concepts

Opportunity Cost

Opportunity cost is a fundamental concept in economics. It represents the value of the next best alternative that is foregone when a choice is made. In simpler terms, it's what you give up in order to do or obtain something else.

In the context of international trade, opportunity cost allows countries to determine what goods they should produce and trade.

• For example, if the United States focuses on producing steel, it forgoes the production of coffee. The opportunity cost is, therefore, the amount of coffee that could have been produced instead of the steel.
• In Brazil, the opportunity cost of producing steel is even higher as they must forgo twice the amount of coffee for each ton of steel.

This concept is crucial for countries to understand to make decisions that maximize their productivity and efficiency.

International Trade

International trade involves the exchange of goods and services between countries. It allows nations to obtain resources and products they cannot produce as efficiently themselves.

Here's why it's beneficial:

• Countries can capitalize on their specific strengths or advantages. For example, Brazil is more efficient at producing coffee while the United States is more efficient at producing steel.
• By trading, countries can enjoy a variety of goods and services at lower costs, boosting their overall wealth.

Through trade, countries can specialize and therefore increase their economic output and living standards.

Specialization

Specialization occurs when a country focuses on the production of specific goods or services that it can produce more efficiently than other goods.

In our example:

• Brazil specializes in producing coffee because it has a lower opportunity cost for coffee compared to steel.
• The United States specializes in steel because it can produce it at a lower opportunity cost than coffee.

Specialization allows countries to allocate resources more efficiently, resulting in increased overall production and economic growth when combined with trade.

Price Convergence

Price convergence happens when the prices of trade goods become similar between different countries as a result of international trade.

Here's how it works in our scenario:

• Prior to trade, the price of steel in terms of coffee was different in Brazil and the United States.
• Once trade begins, these prices tend to move towards a middle ground, leading to a convergence. In this situation, the price of steel in terms of coffee became 1.5 tons for both countries.

This convergence benefits both trading partners by allowing them to buy and sell goods at mutually advantageous prices.

Economics Education

Economics education helps individuals understand the principles and theories that govern economic activities like trade and specialization. A solid grasp of these concepts can help students and professionals make informed decisions.

Why it matters:

• It provides insights into how nations can optimize their economic strategies based on comparative advantages.
• Learners can better appreciate the dynamics of international markets and the role of opportunity costs in shaping trade policies.

By studying economics, individuals are better prepared to analyze and engage with real-world economic situations.