In the previous video, we talked about how economies efficiency produce goods and allocate their resources. This time, we talk about how economies can maximize their consumption and production by specializing and trading!

How is it that 2 individuals or economies can come together and determine a price or exchange rate where goods and services can be trade?

Imagine you have a friend named John and he is great at accounting and you are a master of economics. Which scenario would you prefer:

a) Both you and John never meet for study sessions. You study alone and only meet up for basketball

b) John teaches you accounting and you teach him economics!

I hope that all of you have chosen option B and the rational behind this is that you save a lot of time when there is somebody there to teach you! You have saved on opportunity cost! This little example should give you an idea on how economies come together and make a decision to trade or not.

Watch the video for a more technical explanation!

At the end of the video, you should be able to:

• Determine whether 2 economies should specialize and trade.
• Determine the international price or terms of trade.
• Graphically illustrate the new consumption possibility frontier.

• Tags:

1. M.K says:

My qn is , do i have to make sure that whatever international price chosen (between options 3,4,5) does it have to fit the criteria of BOTH the x and y concurently? And may i know why ONLY the value of 4 was chosen for the international price in this case. if i understand correctly,criteria of both x and y has to be fulfilled concurently and thus value 5 will be inaacurate but would international price value 3 also be inaccurate? tech i could use both the value of 3 and 4 as my international price right?

• Quickienomics says:

Hi, actually it’s not about fitting the criteria for both X and Y at the same time. It’s about making sure that the international price is in between the opportunity cost of the seller and the buyer. Because we already established that both economies have comparative advantages, it means that one country is good at producing X and Y individually.

For your last statement, I don’t think it’s a good idea to choose 3 since you mentioned that 3 doesn’t fulfill the criteria concurrently. Hope that helps. 🙂

• Isabel says:

Hi there, can you explain why 3 or 5 would be inaccurate for this question?

• George says:

I have the same question as Isabel. Why 3 and 5 would be out? I see the whole set {3,4,5} satisfying both conditions… am i wrong?

thank you!

2. irene says:

Hi, i have a question on Specialization and trade, hope you help me

Economy A has 2 types of labour – skilled and unskilled labour. Its skilled labour could produce 100 units of X or 200 units of Y or a linear combination of both goods. Unskilled labour, on the other hand could produce 200 units of X or 100 units of Y or a linear combination of both goods. Economy B only has unskilled labour that could produce 25 units of X or 25 units of Y or a linear combination of both. Only under certain condition that economy A will specialize in producing one good only. T/F. Explain

Thanks

• Quickienomics says:

Hi!

How would you like me to help? Maybe we could be a bit more specific? 🙂

3. irene says:

hi, i managed to solve the question yesterday, thank you
can i ask you another question?
if the qn stated that in the economy the income is compensated, and the price of good increases,even demand for giffen good is downward sloping.
Can i answer the question this way:
income is compensated, so there is no income effect it means the income remained unchanged. when the price goes up, SE is always inverse to price change so demand for giffen good is downward sloping.

• Quickienomics says:

Hi Irene,

Nice! Good analysis of the compensation factor. Yes you are right. Make sure you demonstrate with graphs too yea?

4. irene says:

hi, sorry i mean income effect resulting from an increase in the price of good is always compensated, would be more precise 😀

5. irene says: