Global Economic Analysis - Production Possibility Curves

To illustrate the benefits of trade, we should look at the production possibility curves for two nations, Great Britain and the U.S. The production possibility curve (or production possibility frontier) shows the maximum possible output of an economy. To simplify things, we will assume that only two goods are produced - wheat and steel.

Figure 5.1: Production Possibility Curves

According to the production possibilities curve shown in the above graphs, the U.S. could produce 50 units of wheat per worker, if it devoted all of its resources to wheat production, and zero units of steel. If all resources were devoted to producing steel, then the U.S. would have 50 units of steel per worker and no wheat. If Great Britain devotes all of its resources to making wheat, it can produce 20 units of wheat, with no steel being produced. If that country concentrates all of its resources on producing steel, then 40 units of steel would be produced per worker, with no wheat production. Please note that the U.S. has an absolute advantage over Great Britain with both products because the U.S. workers are more productive than those from Great Britain. However, this is not important from an international trade perspective.

The domestic exchange rate within the U.S. for the two goods is 1:1; for each unit of steel produced, the U.S. must give up producing one unit of wheat. We could say that the cost of one unit of steel within the U.S., assuming no international trade, would be one unit of wheat. Similarly, the cost of one unit of wheat would be the loss of one unit of steel.

Great Britain would have a different domestic exchange rate. Its production possibility curve implies that the cost of one unit of steel would be one-half of a unit of wheat. The cost of one unit of wheat would be two units of steel. These costs can be obtained by looking at the slope of the production possibility curve.

If the U.S. and Great Britain both operated as autarkies (self-sufficient nations that do not trade), then each country would operate somewhere on their production possibilities curve. The exact point of production would depend on each country's supply and demand for the goods. For example, these points could be 35 units of wheat and 15 units of steel for the U.S., and 10 units of wheat and 20 units of steel for Great Britain, as illustrated in Figure 5.1.

Trade Efficiency Rule
Related Articles
  1. Career Education & Resources

    How Hard are the CFA Exams?

    Learn about the difficulty of the CFA exams with a description of the tests, some statistics on pass rates and suggestions that can help you pass the exams.
  2. Professionals

    What it Takes to be a Financial Analyst

    A financial analyst researches companies and economic conditions to make business, sector and industry recommendations.
  3. Career Education & Resources

    Financial Analyst: Career Path & Qualifications

    Read about what it takes to become a financial analyst in a corporation or securities firm, and learn how far you can rise in the profession.
  4. Career Education & Resources

    Financial Planner: Career Path & Qualifications

    Learn what education and certifications you need to become a financial planner, as well as the future prospects and earnings potential for financial planners.
  5. Career Education & Resources

    Where to Find Non-Profit Finance Jobs

    The non-profit sector offers a stable selection of jobs for those who seek other types of fulfillment from their jobs than just purely financial.
  6. Career Education & Resources

    Portfolio Manager: Career Path & Qualifications

    Learn about the basic requirements for getting hired as a portfolio manager, and discover how most professionals in the field rise into the position.
  7. Your Practice

    4 Professional Associations Advisors Should Join

    These four professional organizations are among the most respected and well known in the industry.
  8. Professionals

    Equity Research: Career Path and Qualifications

    Find out what equity research analysts do on a day-to-day basis, and learn more about the typical career progression for these securities professionals.
  9. Professionals

    What's on the CFA Level II Exam?

    The Chartered Financial Analyst Level II exam is the second of three tests that CFA candidates must pass.
  10. Professionals

    Financial Data Analyst: Career Path & Qualifications

    Learn more about the career options available to financial data analysts, and determine whether the profession is a good match for you.
RELATED TERMS
  1. Personal Financial Advisor

    Professionals who help individuals manage their finances by providing ...
  2. CFA Institute

    Formerly known as the Association for Investment Management and ...
  3. Security Analyst

    A financial professional who studies various industries and companies, ...
  4. Chartered Financial Analyst - CFA

    A professional designation given by the CFA Institute (formerly ...
RELATED FAQS
  1. What are the differences between a Chartered Financial Analyst (CFA) and a Certified ...

    The differences between a Chartered Financial Analyst (CFA) and a Certified Financial Planner (CFP) are many, but comes down ... Read Full Answer >>
  2. How do I become a Chartered Financial Analyst (CFA)?

    According to the CFA Institute, a person who holds a CFA charter is not a chartered financial analyst. The CFA Institute ... Read Full Answer >>
  3. What types of positions might a Chartered Financial Analyst (CFA) hold?

    The types of positions that a Chartered Financial Analyst (CFA) is likely to hold include any position that deals with large ... Read Full Answer >>
  4. Who benefits the most from prepaid expenses?

    Prepaid expenses benefit both businesses and individuals. Prepaid expenses are the types of expenses that are bought or paid ... Read Full Answer >>
  5. If I am looking to get an Investment Banking job. What education do employers prefer? ...

    If you are looking specifically for an investment banking position, an MBA may be marginally preferable over the CFA. The ... Read Full Answer >>
  6. Can I still pass the CFA Level I if I do poorly in the ethics section?

    You may still pass the Chartered Financial Analysis (CFA) Level I even if you fare poorly in the ethics section, but don't ... Read Full Answer >>
Hot Definitions
  1. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
  2. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
  3. Ponzimonium

    After Bernard Madoff's $65 billion Ponzi scheme was revealed, many new (smaller-scale) Ponzi schemers became exposed. Ponzimonium ...
  4. Quarterly Earnings Report

    A quarterly filing made by public companies to report their performance. Included in earnings reports are items such as net ...
  5. Dark Pool Liquidity

    The trading volume created by institutional orders that are unavailable to the public. The bulk of dark pool liquidity is ...
Trading Center