Question

In the United States, the opportunity cost of 1 ton of corn is 50 bicycles. In China, the opportunity cost of 1 bicycle is 0.01 tons of corn.

a.Determine the pattern of comparative advantage.

b.In autarky, the United States can produce 200,000 bicycles if no corn is produced, and China can produce 3,000 tons of corn if no bicycles are produced. Draw each country’s production possibility frontier assuming constant opportunity cost, with tons of corn on the vertical axis and bicycles on the horizontal axis.

c.With trade, each country specializes in its production. The United States consumes 1,000 tons of corn and 200,000 bicycles; China consumes 3,000 tons of corn and 100,000 bicycles. Indicate the production and consumption points on your diagrams, and use them to explain the gains from trade.

Short answer

1. The U.S. has a comparative advantage in the production of corn, and China has a comparative advantage in the production of bicycles.
2. The production possibility curve of both the countries is shown below:

c. The production and consumption points for both the countries are indicated on the diagram below:

The trade has increased the total quantity of both goods consumed by the countries, which was not possible under autarky.

Step-by-step solution

Comparing the pattern of comparative advantage for both countries

The comparison between the opportunity costs for producing corn and bicycles by both countries will help determine the comparative advantage of the nations. The comparison would be simple if the opportunity cost is simplified for 1 ton of corn.

In the United States, the opportunity cost for producing 1 ton of corn is 50 bicycles. In China, the opportunity cost of making one bicycle is 0.01 tons of corn. On simplifying, the opportunity cost producing 1 ton of corn is 100 bicycles (1/0.01 bicycles).

On comparing, the opportunity cost of the United States is lower because it has to let go of only 50 bicycles on the production of 1 ton of corn. On the other hand, China has to let go of 100 bicycles for producing 1 ton of corn. Thus, the United States has a comparative advantage in the production of corn.

Similarly, China has a comparative advantage in the production of bicycles because its opportunity cost is lower than the United States. The United States has to let go of 0.02 (1/50) tons of corn to produce 1 unit of bicycle, which is greater than 0.01 ton of corn (opportunity cost of china for making 1 unit of bicycle). Thus, China has a comparative advantage in the production of bicycles.

 Illustrating the production possibility curves for both countries

To draw the production possibility curve for both the countries, one needs to find the quantity of corn produced when no bicycle is produced for the U.S. and the number of bicycles produced when China has no corn. It will help determine the vertical and horizontal intercepts of production possibility curves of both countries.

• For the United States: The U.S is producing 200,000 bicycles when no corn is produced. The opportunity cost of producing 1 unit of the bicycle is 0.02. Thus, it will have 4,000 tons of corn (200,000 bicycles × 0.02 tons of corn/bicycle). The production possibility curve for the United States is shown below:

• For China:China produces 3,000 tons of corn when no bicycle is produced. The opportunity cost of producing 1 ton of corn is 100 bicycles. Thus, it will produce 300,000 bicycles (3,000 tons of corn × 100 bicycles/ton of corn). The production possibility curve for China is shown below:

Illustration of production and consumption points if the countries engage in specialization and trade

• The opportunity cost for producing bicycles is higher for the United States and lower for China. Suppose the U.S. specializes in corn production only and exports it to China in return for bicycles. In that case, it will receive a greater quantity of bicycles in return for corn from China. Its consumption point will lie beyond the production possibility curve as it can consume more quantities of bicycles from the previous autarky situation. The production and consumption points for the United States is shown below:

• The opportunity cost for producing corn is higher for China and lower for the U.S. If China specializes in the production of bicycles only and export it to the U.S. in return for corn, it will receive a greater quantity of corn in return for bicycles from the United States. Its consumption point will lie beyond the production possibility curve as it can consume more quantities of corn from the previous autarky situation. The production and consumption points for China is shown below:

The shift in the consumption point of the countries beyond their production possibility curves shows how specialization and trade have benefitted both countries. The combined quantities for both the goods have increased for consumption in both the countries.