Explain with the aid of community Indifference curve and the production possibility frontier how a country an gain from international trade. ??. What other possible gains from trade are there other than the “gain for exchange” and gains from specialization. ”? ?? The gain from international trade between countries can simply be clarified by the aid of Community Indifference Curves and the production possibility frontier as follows.
The production possibility frontier is the curve that shows the alternative combinations of the two commodities that a nation can produce by fully utilizing all of its resources with the best technology available to it. This production possibility frontier normally has a negative slope indicating that if a country want to produce more of one good, it must give up some of another good(assume that there are only two goods) This is associated with what we call opportunity costs.
In the real world, a nation is inclined to encountering increasing opportunity costs which means that the nation must give up more and more of one commodity to release just enough resources to produce each additional unit of another commodity. Increasing opportunity costs result in a production frontier that is concave from the origin. As has been mentioned the production frontier represents production, or supply consideration.
Community Indifference Curves, on the other hand, reflect the tastes, or demand preferences, in a nation demonstrating the various combinations of two commodities that yield equal satisfaction to the community or nation. Higher curves refer to greater satisfaction, lower curves to less satisfaction. It is always in the case that the community indifference curves are negatively sloped and convex from the origin because as a nation consumes more of one good, it must consume less of another so as to have the same level of satisfaction.
The common slope of these two curves, which reflects the interaction of the forces of demand and supply, at the tangency point gives the internal equilibrium relative community price in the nation. A difference in relative community prices between two nations is a reflection of their comparative advantage and forms the basis for mutually beneficial trade. To illustrate, ‘the equilibrium-relative community price’given by the slope of the common tangent to the nation’s production frontier and indifference curve at the autarky point of production and consumption reflects the nation’s comparative advantage.
The nation with the lower relative price for a commodity has a comparative advantage in that commodity and a comparative disadvantage in the other commodity, with respect to the second nation. It follows that both nation can gain if each nation specializes in the production of the commodity of its comparative advantage (i. e. , produce more of the commodity than it wants to consume domestically) and exchange part of its output with the other nation for the commodity of its comparative disadvantage. However, as each nation specializes in producing the commodity of its comparative advantage, it incurs increasing opportunity costs.
The process of specialization in production will then continues until relative commodity prices in the two nations become equal at the level at which trade is in equilibrium. By trading with each other, both nation ends up consuming more than in the absence of trade, which is determined what we call the gain from international trade. A nation’s gains from trade can be split into two components which are the gains from exchange and th