Comparative Advantage as translated into the driving force behind international trade

In Chapter 2 we saw the importance of comparative advantage in driving trade between individuals. The same force drives trade between nations and regions of the world. When one area has a comparative advantage in producing an item all parties to trade can be made better off by specialization and free trade.

At the moment free trade is getting a pretty bad reputation world-wide due to some very egregious exercises of monopoly power and some extremely corrupt political systems. However, it is usually the case that when trade is free, and not biased by political or monopoly power, everyone gains. This fact is the driving notion behind the fact that the benefit of trade is perhaps the one thing on which economists of all political persuasions can agree.

Exploration: Using individual production possibilities and comparative advantage to generate gain beyond the reach of any one individual acting alone.

Examples 2.5 through 2.8 highlight the fact that individuals (and countries) can jointly benefit from specializing in the production of goods and services in which they have a comparative advantage. In those examples, Tom and Susan (the individuals in this simple two-person economy) produce coffee and nuts. The interactive graph describes Tom and Susan's current productivity (per hour) of these two goods (note that numbers are different than those used in the textbook), while the graphs illustrate their associated individual and combined production possibility frontiers, assuming that each individual works a maximum of 8 hours per day and splits his/her time equally between coffee and nut production. This is exactly as the exercise in Chapter 2. IN this chapter we introduce an new wrinkle – the ability for Tom and Susan to trade together with a third party; the rest of the world. Thus a Terms of Trade or Consumption Possibilities Curve has been added. When turned on the Terms of Trade line will have the slope of relationship between coffee and nuts in the world (or other country if you prefer) and will pass through the point at which Tom and Susan are producing.

1. According to the information in the graph, what is the opportunity cost of coffee for Tom and Susan? What is the opportunity cost of nuts for Tom and Susan? How are these calculated?
   
   
2. Who has a comparative advantage in coffee production? Who has a comparative advantage in nut production? Which good should each person specialize in to boost overall production in the economy?
   
   
3. Initially, each person spends half the day picking coffee and half the day picking nuts. What happens to total production of coffee and nuts in this economy if each person spends the entire day producing the good that he/she has a comparative advantage in? To see the effects of this reallocation of labor hours, change the Coffee Labor Hours values for Tom and Susan in the table above (the Nuts Labor Hours value will change automatically) and see what happens to New Production. What happens to overall production in this economy? What do you conclude about the benefits of specialization?

Exploration: What happens when the opportunity for trade arises?

1. Starting from the initial figures (use the Reset button to reset the values), if Tom and Susan have the ability to trade with another country whose opportunity cost of a pound of coffee is 2.0 pounds of nuts, how will Tom and Susan allocate their labor hours between coffee and nut production?
   
   
2. If the "world" opportunity cost of a pound of coffee falls to 1 pound of nuts, how will Tom and Susan's allocation of labor hours devoted to coffee and nut production change?
   
   
3. What is the range of world prices that will result in Tom and Susan each specializing?

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Exercise picked up from the 2e Microeconomics textbook.