Consumption

Consumption after trade

The relative price determines the benefits of specialization. If the price is closer to Portugal’s opportunity cost of exchanging a bottle of wine for two meters of cloth, then England benefits more from trade. If the price is closer to England’s opportunity cost of exchanging a bottle of wine for three meters of cloth, Portugal will benefit more from trade.

Let’s consider the following example again: Portugal completely specializes in wine while England incompletely specializes in cloth, following a 20/80 share of labor for each good.

Self-sufficiency

Both countries: Share of labor devoted to wine = 0.5

Incomplete specialization

Portugal: Complete specialization
England: Incomplete specialization with labor share devoted to wine = 0.2

With a price between 2 and 3 meters of cloth per bottle, how much do they need to trade to be better off? England needs at least 375 additional bottles of wine to match its consumption under self-sufficiency. Portugal needs to keep at least 500 bottles of wine to match its wine consumption under self-sufficiency. Therefore, the quantity of wine traded will be between 375 and 500 bottles.

The following table allows you to adjust the price and quantity of trade. It represents the final consumption of wine and cloth after trade. You can change the prices and amounts traded to verify the conditions that cause trade to increase Portugal and England’s consumption of goods compared to self-sufficiency.

Consumption after trade

Trade enables both countries to increase consumption of both goods, but the gains from trade depend on the relative prices of the two goods. They can distribute the gains from specialization to end up better off. Observe what happens when you set the price closer to 2 or 3 meters per bottle. Which country gains more from trade?