Assume a two-country, two-commodity, two-input model. Let the countries in the model be the United States and the Rest of the World and the goods be steel and wheat. The two factors of production are capital and land. Further, the United States is capital-abundant and steel production is capital-intensive. Suppose, in the absence of trade, the United States operates at a point on its production-possibility curve where it produces and consumes twenty units of wheat and twenty units of steel. Once it engages in free trade, the international price of one unit of steel is two units of wheat. In response to the opening of trade, the United States moves along its production-possibility curve to a new point where it produces thirty units of steel and ten units of wheat. Is the United States
better off following the opening of trade? Provide a logical proof of your answer.
What will be an ideal response?
POSSIBLE RESPONSE: The opening of trade allows the United States to partially specialize in the production of steel because steel is capital-intensive and the United States is relatively capital-abundant. We need to compare the well-being of the United States in the absence of trade to that after it engages in free trade. In the absence of trade, the United States consumes twenty units of steel and twenty units of wheat.
When free trade is allowed, the United States can extend the production of steel to thirty units, that is, by ten units. The amount of wheat foregone is also ten units; the production of wheat decreases from twenty units to ten units. However, in the international market the United States can exchange one unit of steel for two units of wheat. If the United States would sell the ten extra units of steel produced for twenty units of wheat, the United States could consume thirty units of wheat and twenty units of steel. This is better than the no-trade situation of consuming only twenty units of wheat and twenty units of steel. The country is thus better off following the opening of free trade.
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Fill in the blank(s) with the appropriate word(s).
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