Problem: The production possibilities tables for Malaysia and the United States are shown in the tables below. Before specialization and trade, Malaysia's optimal product mix is given by alternative C while optimal production in the U.S. is alternative J. | Malaysia Production Possibilities | Product | A | B | C | D | E | Clothing | 20 | 15 | 10 | 5 | 0 | Grain | 0 | 3 | 6 | 9 | 12 | | | | | | | | U.S. Production Possibilities | Product | G | H | I | J | K | Clothing | 32 | 24 | 16 | 8 | 0 | Grain | 0 | 10 | 20 | 30 | 40 |
a. | What is Malaysia's marginal opportunity cost of clothing? Of grain? | b. | What is the U.S. marginal opportunity cost of clothing? Of grain? | c. | Should these two countries specialize? If so, in what products should they specialize? | d. | What is the total gain in production that could be achieved through specialization? | e. | What are the limits on the terms of trade between the two nations? | f. | Following specialization, suppose Malaysia exports 10 units of clothing to the U.S. in exchange for 10 units of grain. What are the gains from trade for each country? |
| Answer: a. | In Malaysia, 5 more units of clothing can be produced by giving up 3 units of grain. The opportunity cost of clothing is then 3/5 = 0.6 units of grain. The opportunity cost of grain is 5/3 = 1.67 units of clothing.
| b. | In the U.S., 8 additional units of clothing can be produced by giving up 10 units of grain. The opportunity cost of clothing is then 10/8 = 1.25 units of grain. The opportunity cost of grain is 8/10 = 0.8 units of clothing.
| c. | Malaysia has a lower opportunity cost of clothing while the U.S. has a lower opportunity cost of grain. Malaysia should specialize in clothing and the U.S. in grain.
| d. | Prior to specialization, the two countries’ combined clothing production was 18 (10 in Malaysia and 8 in the U.S.). Total grain production was 36 (6 + 30). With complete specialization, Malaysia will produce 20 units of clothing (a gain of 2 over the previous combined total) and the U.S. 40 units of grain (a gain of 4 units.)
| e. | The terms of trade can vary anywhere between the pre-trade opportunity cost ratios. That is, anywhere between 1 unit of clothing for 0.6 units of grain and 1 unit of clothing for 1.25 units of grain.
| f. | Following trade, Malaysia would have 10 units of clothing (production of 20 minus exports of 10) and 10 units of grain. Compared to its pre-trade choice at C, it has gained 4 units of grain. The U.S. would obtain 10 units of clothing and retain 30 units of grain (production of 40 minus its exports of 10.) This is a gain of 2 units of clothing compared to its pre-trade position. |
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