Why do nations trade? The principle of comparative advantage can help to explain how countries with different endowments of resources can, through specialization and exchange, enhance the economic conditions of their residents. If each country specializes in the production of the good in which it has a comparative advantage, trade will allow each country to consume greater amounts of all goods than would be possible without trade.

The graph shows the production possibilities for the United States and Brazil for two goods, coffee and wheat. The straight-line production possibilities curves (red for the U.S., blue for Brazil) assume that there are constant opportunity costs of production for the two goods, although these costs differ in the two countries. The different endowments of the two countries are also reflected in the graph: The U.S. can produce more total wheat than can Brazil while Brazil can produce more coffee. Prior to any trade, each country has opted to use half of their resources to produce each of the goods. Any gains from trade reported in the table are relative to these initial levels of production and consumption.

To use the graph, click on any of the bold entries in the table and change their values. Entries in the first column determine how much specialization a country will undertake in coffee. Entries in the second column will automatically adjust to determine the production of wheat possible with that degree of specialization. Click on the amount of U.S. exports desired, either wheat or coffee. The terms of trade will determine the amount exchanged with Brazil. The terms of trade, shown by the green line on each graph, are initially set at 2 units of wheat for 2 units of coffee. To change the terms of trade, click on either of the boxes at the bottom of the graph and enter a new value.

Clicking on the Opp. Costs box will reveal the domestic opportunity costs faced by each country; Reset will reset all values to their initial levels.

1. Which country is the lower opportunity cost producer of coffee?
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2. Which country is the lower opportunity cost producer of wheat?
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3. Suppose the U.S. wishes to consume 48 units more coffee than its current consumption of 80 units, which it could do by devoting 80% of its resources to coffee production. Which would be better, producing the extra coffee itself, or importing it from Brazil at the current 2 for 2 terms of trade?
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4. At the current terms of trade, how might specialization allow residents in the U.S. to consume more coffee without giving up any wheat?
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5. Experiment on your own. How is it possible for both Brazil and the U.S. to be unambiguously better off after trade?
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6. Experiment on your own. What are the limits on the terms of trade that will allow both countries to be better off through trade?
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