Without international trade, the bundle of goods produced
must be the same as the bundle consumed. With international
trade, the consumption and production bundles can be altered
independently to reflect the relative values placed on goods by
international markets.
Fixed Production
In both accompanying figures, the purple curve is the
economy’s production possibilities boundary. In the absence of
international trade, the economy must consume the same
bundle of goods that it produces. Thus, the production
possibilities boundary is also the consumption possibilities
boundary. Suppose the economy produces and consumes at
point a, with of good X and of good Y, as in the first figure.
Next suppose that production remains at point a but we now
allow good Y to be traded for good X internationally. The
consumption possibilities are now shown by the line tt drawn
through point a. The slope of tt indicates the quantity of Y that
exchanges for a unit of X on the international market—that is,
the relative price of X in terms of Y.
Although production is fixed at point a, consumption can now
be anywhere on the line tt. For example, the consumption point
could be at b. This could be achieved by exporting units of
Y and importing units of X. Because point b (and all others
on line tt to the right of a) lies outside the production
possibilities boundary, there are potential gains from trade.
x 1 y 1y 2 y 1
x 1 x 2