Money, Banking, and International FinanceIf Mexico and the United States engage in free trade, subsequently, the countries specialize
in producing products where they have low opportunity costs. Opportunity cost reflects the
slopes of the PPCs. Slope for the United States equals 0.5, which means the U.S. must give up
the production of one car to produce 0.5 tomatoes. On the other hand, Mexico has a slope of 2. It
can produce two tomatoes by giving up one car. Consequently, the United States specializes in
car manufacturing while Mexico specializes in growing tomatoes.
Straight-line PPCs lead to complete specialization, whereas curved PPCs have partial
specialization because curved PPCs experience increasing opportunity costs as an industry
expands. With complete specialization, the United States produces all cars while Mexico
produces all tomatoes because the opportunity costs do not change. U.S. entrepreneurs
continually shift resources from the tomato industry into the car industry until they reach the
maximum car production. On the other hand, the Mexico entrepreneurs do the exact opposite.
Consequently, the United States produces 100 cars and grows zero tomatoes while Mexico
grows 60 tomatoes and produces zero cars. Gain in world production equals 35 cars and 5
tomatoes. Unfortunately, we need more trade theory to predict how the countries would divide
this extra production between themselves.
This simple analysis of free trade has limitations. First, this analysis does not include the
role of technology, or the flow of resources from one country to another. Second, this analysis
does not include outsourcing. Outsourcing is a firm contracts part of its production to another
firm in another country, and it has become very popular. Finally, the communication and
transportation costs are decreasing, which strengthens outsourcing and the flow of resources.
Key Terms
sole proprietorship
partnership
corporation
shareholder
initial public offer
charter
stock
mutual agency relationship
dividend
common stock
preferred stock
Cumulative Preferred Stock
Protected Preferred Stock
Redeemable Stock
Convertible Stock
tax evasion
tax avoidance
return
dividend yield
capital gain
special purpose entity
keiretsu
principal-agent problem
multinational corporation
multinational enterprise
economic exposure
mature economies
emerging-market economies
open-market place
strategic management
outsource
country risk
Law of Comparative Advantage
production possibilities curve (PPC)
complete specialization