Macroeconomics
ab = exports of 10 trains
bc = imports of 30 boats
In thiscase,tradingwillincreasethecountry’stotalquantityofproductsthatcanbeconsumed.Ifthe country had initially produced 40 trains, the maximum output of boatsitcouldproducewouldbe20. However, if it engages in trade, it canspecializeintrainproductionmaking50trains.Itcanexport10 trains in exchange for 30 imported boats, enabling it to movefrompointXtopointYandenjoymore products. Countries involved in trade would be willing to exchange goods and services under an exchangerate condition or ratio referred to as the termsoftrade or tradingprice .Ingeneral,nocountryengagesin tradeifthepriceofthegoodobtainedfromtradeishigherthanthecountry’sowndomesticopportunity cost.
For example, ifCanadaandMexicoproducemeatandpotatoes,where1 ozofmeat=¾ozofpotatoesinCanada,Canadamustgetmorethan¾oz of potatoes for each oz of meat exported; otherwise, it will not beneft from exporting meatinexchangeforMexicanpotatoes.Canadamustget more potatoes for its meat through international trade than it can get domestically; otherwise, no trade will occur since Canada will notmake any fnancial gain. Similarly, if 1 oz ofmeatequals2ozofpotatoesinMexico,Mexicomust get 1 oz of meat by exporting some amount less than 2 ozofpotatoes. Mexico must be able to pay a lower price for meat when trading with
Canada than it must pay domestically; otherwise, no trade will occur. Therefore, the terms of trade would lie somewhere between the opportunity costs in the two countries: ¾ ozofpotatoes<1ozof meat < 2 oz of potatoes.
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