International Economics 8th Edition Appleyard Solutions Manual Download

Chapter 06 - Gains from Trade in Neoclassical Theory
International Economics 8th

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CHAPTER 6
GAINS FROM TRADE IN NEOCLASSICAL THEORY
Learning Objectives:
■ Describe economic equilibrium in a country that has no trade.

■ Discover the welfare-enhancing impact of opening a country to international trade.
■ Demonstrate that either supply differences or demand differences between countries are
sufficient to generate a basis for trade.
■ Discuss the implications of key assumptions in the neoclassical trade model.
I. Outline
Introduction
- The Effects of Restrictions on U.S. Trade
Autarky Equilibrium
Introduction of International Trade
- The Consumption and Production Gains from Trade
- Trade in the Partner Country
Minimum Conditions for Trade
- Trade between Countries with Identical PPFs
- Trade between Countries with Identical Demand Conditions
6-1
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- Conclusions
Some Important Assumptions in the Analysis
- Costless Factor Mobility
- Full Employment of Factors of Production
- The Indifference Curve Map Can Show Welfare Changes
Summary
Appendix: “Actual” versus “Potential” Gains from Trade
II. Special Chapter Features
In the Real World: Changes in Income Distribution with Increased Trade
III. Purpose of Chapter
The purpose of this chapter is to build the case, using familiar microeconomic tools, for a
country to participate in international trade rather than to remain in autarky. The chapter thus
uses more modern or updated analysis, compared to the Classical model, to evaluate the impact
of trade. The chapter also attempts to acquaint the student with some of the important
underlying assumptions in this neoclassical analysis.
IV. Teaching Tips
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A. The chapter begins with an analysis of the costs of trade restrictions in terms of lost
imports and exports. This provides students with a real-world estimate of the potential gains
from free trade as a motivation for the theoretical discussion in this chapter.
B. We find it useful to dwell on the production equilibrium material, since students don’t
usually seem to have an economic grasp of why the equilibrium production point on the PPF
emerges in the standard competitive framework.
C. When introducing the effects of international trade it is worthwhile to stress that the
“trading line” is in fact the consumption-possibilities frontier (CPF) with trade. This CPF is
outside the economy’s CPF in autarky (which is identical to the PPF), except at the point of
tangency to the PPF.
D. The consumption gain from trade sometimes puzzles students. It can be useful to explain
this gain as the natural result of receiving a relatively higher price for the good now sold on the
world market, coupled with paying a relatively lower price for the good now bought on the world
market.
E. It can be helpful in discussing the case of identical PPFs and different tastes to emphasize
that the gains for each country occur because they are each getting more of the good for which
they have relative preference. However, note that trade does not occur because of the different
tastes per se but rather because of the different opportunity costs resulting from the different
tastes in the increasing-opportunity-cost framework.
F. The discussion in the last section regarding underlying assumptions seems to be of

interest to students. It is useful to stress that policies that facilitate mobility and adjustment to
trade (such as trade adjustment assistance), as well as possible compensation measures, can help
to ensure that the actual gains from trade are maximized in practice.
V. Answers to End-of-Chapter Questions and Problems
1. Figures 1 and 2 in the text are the relevant diagrams. Point E is the production
equilibrium position because the marginal rate of transformation in production (= marginal cost
of X/marginal cost of Y) is equal to the relative commodity price ratio PX/PY at that point. For
the given relative prices, production at any other point would have PX/PY unequal to MCX/MCY,
or PX/MCX unequal to PY/MCY. Hence, firms would have an incentive to shift resources until
point E was attained.
For consumers, point E in Figure 2 is the equilibrium position because, at that point, the
marginal rate of substitution in consumption (= marginal utility of X/marginal utility of Y) is
equal to PX/PY. Consumption on the PPF at any other point would be on a lower indifference
curve, and, for the given prices, MUX/MUY would be unequal to PX/PY (or MUX/PX would be
unequal to MUY/PY). Because consumption of one good at the margin brings less utility per
dollar spent than on the other good, consumers will change their consumption bundle until point
E is attained.
6-3
In order for the country to gain from trade, the world PX/PY must be different from the
autarky PX/PY. With different relative prices on the world market, a reallocation of production
and consumption will enable the country to move to a higher indifference curve.
2. Yes, the country should trade. It should export cloth because that is the good of
comparative advantage, and producers will have a profit incentive to sell cloth at its relatively
higher price on the world market. The country will gain from trade because its trading line (CPF
with trade) will permit larger consumption bundles than are possible in autarky, since the
exported cloth allows for the purchase of relatively cheaper machines than in autarky. As long
as world prices differ from autarky prices, the country can move to a higher indifference curve
by participating in trade.
3. The “gains from exchange” (“consumption gain”) occur because of the opportunity to
consume at different relative goods prices, even though production does not change. The higher
relative price for the export good on the world market permits consumption of the now-relatively
lower priced import good, and consumers will substitute toward the import good and will move
to a higher indifference curve than was possible in autarky. The “gains from specialization”
(“production gain”) reflect the enhanced real income possible for the economy because the
economy is now using resources more efficiently by concentrating its production to a greater
extent on its comparative advantage good.
4. Yes. Even though unemployment may not fall with the opening of the country to trade,
the country can still be reallocating production (increasing the proportion of employed workers
in the export industry and decreasing the proportion in the import-substitute industry) and can
trade along a CPF different from the CPF being attained in autarky. The consumption and
production gains from trade can still be realized. In fact, consumption could now even occur
outside (rather than inside) the PPF with a sufficient volume of trade. Further, even if no
workers can be shifted to the export industry from the import-substitute industry (or from the
unemployment pool) because of rigidities, the consumption gain from trade will still occur.
5. The statement is incorrect. This is the case of trade with a “right-angle” PPF. The
consumption gain from trade will still be realized because trade has exposed the country to a
different set of relative commodity prices.
6. Without getting into material generally beyond the scope of the undergraduate course
(such as the conditions discussed in the Tower article cited in the text or in Miltiades
Chacholiades, International Trade Theory and Policy, Chapter 5), the general statements
regarding the indifference curve map and welfare changes found in the section entitled “The
Indifference Curve Map Can Show Welfare Changes” can be used to answer this question.
7. This position reflects a misunderstanding of the nature of the gains from trade. With
trade, both countries become better off in that movement can take place to a higher community
indifference curve in each nation. Certainly U.S. producers in industries that would now
compete with Cuban exports (principally sugar) would be injured, but U.S. consumers of sugar
would gain, as would U.S. producers of new exports to Cuba (such as machine tools). As this
chapter has explained, if the compensation principle is employed, those who gain from trade can
6-4
fully compensate all losers and still be better off because a larger quantity of goods is available.
Of course, relaxation of the embargo involves political dimensions as well as economic
dimensions, and these noneconomic aspects need to be taken into account when deciding upon
the most desirable course of action.
8. It is not likely that trade would cease even if production conditions were to become
identical (identical technologies and relative factor endowments). This is because there would
still be a basis for trade as long as demand conditions (as reflected in the two community
indifference maps) continued to be different for the two countries.
9. While the opening of trade improves the overall well-being of a country, it can affect the
distribution of real income and leave certain individuals less well off. This result occurs because
the price of the export good is rising, the price of the import good is falling, and factor prices are
changing. In this case, Ms. Jones is correct about her situation but not about the situation of the
country. Also, as will be seen in Chapter 8, if Ms. Jones owns the abundant factor used
intensively in food production (the export), her real income should be rising because the price of
the abundant factor rises to a greater relative extent than does the price of the export good (via
the Stolper-Samuelson theorem and the magnification effect). In this instance, her conclusion
about her own situation is incorrect. If, however, she owns the scarce factor of production, she
will be strictly worse off since she will be faced with both an increased price of food and a
falling income due to the decline in the price of the scarce factor. If Ms. Jones falls into the latter
category, she should lobby for “compensation” from those whose real income has clearly
increased from trade rather than for the imposition of trade restrictions which would lead to a fall
in real income for the economy as a whole.
10. Even though a change in the indifference map makes it impossible to compare the new
and old indifference curves in a meaningful way, it is still possible that a conclusion regarding
the gains from trade can be reached by comparing the old consumption bundle with the new
consumption bundle. If a country is consuming more of both goods after trade or the same
amount of one good and more of the other it can be concluded that the country is better off with
trade. This conclusion rests on the long-held axiom that more is preferred to less. However, if
trade involves moving to a consumption point which involves having more of one good and less
of the other, a clear ambiguity exists. Such an ambiguity can potentially be removed, however, if
by changing the trade bundle, the country can move to a consumption situation where winners
could compensate losers and where no one is worse off and at least one person is better off. See
the appendix for more discussion.
6-5
VI. Sample Exam Questions
A. Essay Questions
1. In the equilibrium trading position in a two-country model of trade, why must the trade
triangles of the two countries be congruent (identical)? What role does the slope of the world
price line play in making the triangles congruent?
2. The text has demonstrated that, even if a country’s production does not change with the
opening of the country to trade, a gain (the “consumption gain”) can still occur even though there
is no “production gain.” Is the reverse situation possible – that is, can there be a “production
gain” without there being a “consumption gain” for the country? Why or why not?
3. “In a situation of increasing opportunity costs, trade can be beneficial to both

countries if they have identical PPFs or if they have identical tastes. However,
trade cannot be beneficial to either country if the countries have identical PPFs
and identical tastes.”
Is this statement correct or incorrect? Illustrate and explain.
4. (This question pertains to material in the appendix.) Explain the economist’s distinction,
in discussion of the compensation principle, between “potential” gains from trade and “actual”
gains from trade. Why are the gains only “potential” when that word is used?
5. Suppose that the trade pattern of a country is that it exports foodstuffs and imports fancy
sports equipment. Can you make a case that trade acts like a regressive tax in its impact on the
distribution of real income and welfare within the country? Explain.
6. Explain, using the PPF-indifference curve diagram, how a change in tastes can cause a
country to shift from being an exporter of a good to being an importer of that same good.
(Assume that world prices are constant.)
7. (a) Using the neoclassical model, build the case why it is beneficial for a country to
move
from a situation of autarky to a situation of free trade.
(b) Briefly, why can the neoclassical model of trade be regarded as “better” in some
respects than the Classical model of trade?
8. Illustrate and explain, for each statement below, why the statement is either TRUE or
FALSE. Assume a two-commodity world in each case.
(a) “If a country has an absolutely fixed production pattern, i.e., resources used
in each industry are completely specific to their respective industry, then this
6-6
country cannot experience any welfare gain when moving from autarky to free
trade.”
(b) “It is possible that, even if two countries have identical production-
possibilities frontiers, trade between the countries can enhance the well-being
of each country, in comparison with well-being under autarky.”
9. (a) Suppose that two countries have identical increasing-opportunity-costs production-

possibilities frontiers (PPFs). Illustrate and carefully explain why, under certain
conditions, the two countries can have an incentive to trade with each other. In addition,
illustrate and explain how they can therefore both gain from trade.
(b) Suppose that two countries, in a situation where they each have an increasing-
opportunity-costs production-possibilities frontier (PPF), have identical tastes and
preferences (demands). Illustrate and carefully explain why, under certain conditions, the
two countries can have an incentive to trade with each other. Why can they gain from
trade?
10. (a) Using the neoclassical production-possibilities frontier/indifference curve approach,

build the case that free trade is preferable to autarky for a country. Then explain how an
economist could still say that trade can be beneficial to the country even if trade causes
the community indifference curve map to change such that the country appears to lose
welfare on the basis of the original autarky income distribution.
(b) It has often been pointed out in this course that, within a country, a movement to
freer trade, while helping some people, can hurt other people. Thinking over various
parts of this course, indicate two groups of people within a country who can have their
well-being reduced because of the opening of the country to trade and very briefly explain
why their welfare can be reduced.
B. Multiple-Choice Questions
11. Which of the following does not contribute to a basis for trade between two countries?
a. different tastes and preferences

b. different technologies
c. different relative factor endowments
* d. different absolute factor endowments, but the same relative endowments
12. Given the following graph showing production-possibilities frontiers for country A and
country B in a situation where both countries are on the same community indifference
curve S1 in autarky:
6-7
Prior to trade, PX/PY in country A is __________ PX/PY in country B, and, when trade
begins, country A will import good __________.
* a. greater than; X
b. greater than; Y
c. less than; X
d. less than; Y
13. Given the production-possibilities-frontier/community-indifference-curve diagram below,

where P is the autarky production point, C is the free trade consumption point, P1
represents autarky prices, and P2 represents free-trade prices, the free-trade production
point is __________ and the autarky consumption point is __________.
a. R; G
* b. R; P
c. P; G
d. G; P
14. In the diagram in Question #13 above, as the country moves from autarky to free trade,
the difference between the S0 and S1 satisfaction levels is called the
* a. “consumption gain” (or “gains from exchange”).

b. “production gain” (or “gains from specialization”).
c. “total gains from trade (both “consumption gain” and “production gain”).
d. “lost tariff revenue effect” from removing protective tariffs.
6-8
15. In the following graph showing indifference curves for country A (a1) and for country B
(b1) in a situation where both countries have the same production-possibilities frontier, in
autarky, PX/PY in country A is __________ PX/PY in country B, and, if trade begins,
country A will export good __________.
* a. less than; X
b. less than; Y
c. greater than; X
d. greater than; Y
16. If country A’s (PX/PY) in autarky is greater than the (PX/PY) on the world market, then, as
the country moves from autarky to trade, the relative price of good X facing A’s
producers will __________, and A’s producers will hence want to shift their production
toward producing __________.
a. decrease; more of good X and less of good Y
* b. decrease; more of good Y and less of good X

c. increase; more of good X and less of good Y
d. increase; more of good Y and less of good X
17. If two countries with increasing opportunity costs have identical PPFs but different tastes,
a. the countries will have identical relative commodity prices under autarky, and
therefore there is no incentive to trade.
b. the countries will have different relative commodity prices under autarky, but there
will still be no incentive for them to trade.
c. the countries will have different relative commodity prices under autarky, and each
country can gain by exporting the good for which its consumers have the higher relative
preference.
* d. the countries will have different relative commodity prices under autarky, and each
country can gain by exporting the good for which its consumers have the lower
relative preference.
6-9
18. Given the diagram below, which shows country A in its autarky position at point E
[where the price line labeled p0 is tangent to both country A’s production-possibilities
frontier (PPF) and country A’s indifference curve S0]:
If country A now is opened to international trade in a situation where the price of bread
relative to the price of meat is lower on the world market than it is in A’s autarky
position, then __________; with international trade, country A will be __________.
a. country A will face a steeper price line than p0 and will change production to a point
on the PPF that is downward and to the right from point E; exporting meat and
importing bread
b. country A will face a steeper price line than p0 and will change production to a point
on the PPF that is downward and to the right from point E; exporting bread and
importing meat
* c. country A will face a flatter price line than p0 and will change production to a point on
the PPF that is upward and to the left from point E; exporting meat and importing
bread
d. country A will face a flatter price line than p0 and will change production to a point on
the PPF that is upward and to the left from point E; exporting bread and
importing meat
19. In the neoclassical model of trade, the movement of a country from autarky to free trade
generally results in __________ specialization in production, __________ the situation in
the Classical model.
a. complete; unlike
b. complete; as was also
* c. partial; unlike
d. partial; as was also
6-10
20. Given the following diagram showing a fixed-quantity production-possibilities frontier, a

community indifference curve, and the associated autarky price line, if this country is
opened to trade through exposure to different relative prices, the country can attain
a. both a “production gain” (“gains from specialization”) and a “consumption gain”

(“gains from exchange”).
b. neither a “production gain” (“gains from specialization”) nor a “consumption gain”
* c. a “consumption gain” (“gains from exchange”) but not a “production gain” (“gains
from specialization”).
d. a “production gain” (“gains from specialization”) but not a “consumption gain”
21. In the diagram in Question #20 above, suppose that this country is opened to trade from
this initial situation where the dashed line indicates autarky prices [(PX/PY)autarky]. With
this opening to trade,
a. the country can gain from trade if PX/PY on the world market is less than (PX/PY)autarky
but cannot gain from trade if PX/PY on the world market is greater than
(PX/PY)autarky.
b. the country can gain from trade if PX/PY on the world market is greater than
(PX/PY)autarky but cannot gain from trade if PX/PY on the world market is less than
(PX/PY)autarky.
* c. the country can gain from trade if PX/PY on the world market is less than (PX/PY)autarky
and also can gain from trade if PX/PY on the world market is greater than
(PX/PY)autarky.
d. the country cannot gain from trade if PX/PY on the world market is less than
(PX/PY)autarky and also cannot gain from trade if PX/PY on the world market is
greater than (PX/PY)autarky.
6-11
22. If a country’s PX/PY in autarky is less than the PX/PY on the world market, then this
country has a comparative advantage in the __________ good, and, if the country now
engages in international trade and moves along its production-possibilities frontier, its
production of the X good will __________.
a. Y; increase
b. Y; decrease
c. X; decrease
* d. X; increase
23. If a country’s PX/PY in autarky is less than the PX/PY on the world market, then, as the
country moves from autarky to trade, the relative price of good Y will __________ for
home consumers. Thus, consumers with a strong relative preference for good
__________ would tend to oppose the movement to trade.
a. increase; Y
b. increase; X
c. decrease; Y
* d. decrease; X
24. If two countries have identical production-possibilities frontiers but different tastes, it is
possible for each country to gain from trade with the other country
a. in the Classical model but not in the neoclassical model.

* b. in the neoclassical model but not in the Classical model.
c. in both the Classical model and the neoclassical model.
d. in neither the Classical model nor the neoclassical model.
25. In the neoclassical (or modern) theory, two countries with identical production-
possibilities frontiers (PPFs)
* a. can gain from trade with each other if demand conditions (tastes) differ in the two
countries and the identical PPFs demonstrate increasing opportunity costs.
b. can gain from trade with each other if demand conditions (tastes) differ in the two
countries and the identical PPFs demonstrate constant opportunity costs.
c. can gain from trade with each other even if demand conditions (tastes) are identical in
the two countries as long as the identical PPFs demonstrate constant opportunity
costs.
d. cannot gain from trade with each other under any circumstances.
6-12
26. As a country moves from autarky to trade, the relative price of the country’s export good
will __________ for home consumers, and the relative price of the country’s import good
__________ for home consumers.
a. fall; will rise

b. fall; also will fall
c. rise; also will rise
* d. rise; will fall
27. In the following graph, at point W (and ignoring the negative signs), the marginal rate of
transformation (MRT) in production __________ the marginal rate of substitution (MRS)
in consumption.
a. is greater than
b. is equal to
* c. is less than
d. has no determinate relationship to
28. Suppose that a country’s factors of production are “completely specific” to the industries
in which they are located (i.e., factors in the X industry would contribute nothing to Y
output if they were employed in the Y industry and factors in the Y industry would
contribute nothing to X output if they were employed in the X industry). In addition,
suppose that the country has an autarky PX/PY that is greater than the world PX/PY. In this
situation, if the country is opened to international trade, it will
a. export good X and will obtain “gains from specialization” (a “production gain”) but
not “gains from exchange” (a “consumption gain”).
b. export good X and will obtain “gains from exchange” (a “consumption gain”) but not
“gains from specialization” (a “production gain”).
c. export good Y and will obtain “gains from specialization” (a “production gain”) but
not “gains from exchange” (a “consumption gain”).
* d. export good Y and will obtain “gains from exchange” (a “consumption gain”) but not
“gains from specialization” (a “production gain”).
6-13
29. Given the diagram below, in which country A is producing at point P and consuming at
point C:
Country A is __________, and the ratio of the price of food relative to the price of books
[i.e., (Pfood/Pbooks)] reflected by price line P0 is __________ than the (Pfood/Pbooks) ratio that
existed when country A was in autarky.
a. exporting food and importing books; lower

* b. exporting food and importing books; higher
c. exporting books and importing food; lower
d. exporting books and importing food; higher
6-14

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Chapter 06 - Gains from Trade in Neoclassical Theory

International Economics 8th

Solution Manual: https://testbankpack.com/p/solution-manual-for-

Test Bank: https://testbankpack.com/p/test-bank-for-international-

■ Describe economic equilibrium in a country that has no trade.

II. Special Chapter Features

In the Real World: Changes in Income Distribution with Increased Trade

III. Purpose of Chapter

IV. Teaching Tips

F. The discussion in the last section regarding underlying assumptions seems to be of

V. Answers to End-of-Chapter Questions and Problems

VI. Sample Exam Questions

3. “In a situation of increasing opportunity costs, trade can be beneficial to both

Is this statement correct or incorrect? Illustrate and explain.

9. (a) Suppose that two countries have identical increasing-opportunity-costs production-

10. (a) Using the neoclassical production-possibilities frontier/indifference curve approach,

a. different tastes and preferences

13. Given the production-possibilities-frontier/community-indifference-curve diagram below,

* a. “consumption gain” (or “gains from exchange”).

a. decrease; more of good X and less of good Y

* b. decrease; more of good Y and less of good X

20. Given the following diagram showing a fixed-quantity production-possibilities frontier, a

a. both a “production gain” (“gains from specialization”) and a “consumption gain”

a. in the Classical model but not in the neoclassical model.

a. fall; will rise

a. exporting food and importing books; lower

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