Steps for International Trade Using the PPC Graph

When an example has one country, the PPC is modeled as curved – which is more accurate. When two countries are trading, it is a useful simplification that improves the model to draw all lines straight.

  1. Use the data to draw two straight-line PPCs in one, fully-labeled, X-Y space.

(Daily) / Trinidad = T / Sicily = S
Milk (in gallons) = M / 5,000 / 100,000
Cell Phones = C / 30,000 / 40,000

2. Set up tradeoff ratios. Change the numbers below Trinidad into a fraction:

Trinidad Now, do the same for Sicily: Sicily

M (Milk) 5,000 100,000

C (Cell Phones) 30,000 40,000

Reduce the numerator to 1. Now the fractions become:

Trinidad Now, do the same for Sicily: Sicily

M (Milk) 1 1

C (Cell Phones) 6 0.4

3. Draw a “Combined PPC without Trade” line. This is just a straight line between the points where both countries have hypothetically put all their resources into producing one good. Go back to the original data. If both Trinidad and Sicily produce milk, up to 5,000 gallons can come from Trinidad and up to 100,000 Sicily. So, combined they can make up to 105,000. Mark the quantity of 105,000 on the Milk axis. Similarly for cell phones, 30,000 (from Trinidad) + 40,000 (from Sicily) = 70,000. Mark this quantity on the Cell Phones axis. Now draw a straight line between 70,000 phones and 105,000 gallons, and label it “Combined PPC without Trade.”

4. Determine Specialization and draw a “Combined PPC with Trade” line. The tradeoff ratio fractions ask the question, how much does it cost to produce milk (the good in the numerator, the top of the fraction) in each country. In Trinidad the opportunity cost of a gallon of milk is 6 cell phones. In Sicily the cost to make the gallon of milk is 0.4 cell phones. Sicily has lower opportunity cost in the production of milk (their denominator is lower; 0.4 is less than 6) so they have comparative advantage in milk and should specialize in dairy. Trinidad should specialize in cell phones. Draw the point that would indicate both nations have gone 100% into their specialty. Trinidad produces 30,000 cell phones and Sicily produces 100,000 gallons of milk. That (30,000, 100,000) point is labeled “C.” Draw lines to connect point C to the same axes intercepts (70,000 phones and 105,000 gallons) you found in Step 3. Label this line “Combined PPC with Trade.”

5. Write Terms of Trade Statements. Without more information (which is usually never given) we can’t say exactly how many of Trinidad’s cell phones will trade for a gallon of Sicilian milk, but we can state it as a range. Take the two denominators from the above fraction you had in Step 2 once you had already equalized the numerators to 1.

Terms of Trade Statement 1:

One gallon of milk will trade for between _____ and _____ cell phones.

Insert the two denominators in the blanks. It is customary to put the smaller number first.

Terms of Trade Statement 1:

One gallon of milk will trade for between 0.4 and 6 cell phones.

To do the same thing for one cell phone, you should go back to the original data. Flip the tradeoff ratios so that you are now looking at not Milk/Cell Phones (M/C) but C/M for both countries. As in:

Trinidad Now, do the same for Sicily: Sicily

C (Cell Phones) 30,00040,000

M (Milk) 5,000 100,000

The fractions reduce to:

Trinidad Now, do the same for Sicily: Sicily

C (Cell Phones) 11

M (Milk) 0.167 2.5

And the Terms of Trade Statement is:

Terms of Trade Statement 2:

One cell phone will trade for between 0.167 and 2.5 gallons of milk.