ABSTRACT
In his neatly constructed example (Figure 5.1), Samuelson (2001) reveals larger gains from trade when produced intermediate goods cross borders as opposed to final goods alone. Portugal (no asterisk) and England (asterisk) have at their disposal three constant returns to scale processes. In each country under autarky, linear combinations of labor-only processes define a transformation locus that dominates the one using labor and cloth to produce wine (in Portugal) and labor and wine to produce cloth (in England). An efficient world transformation locus is constructed, starting at maximum world output of wine, even though unsustainable, as none of the necessary cloth is produced in either country. From a in Figure 5.1, minimum opportunity cost assigns England’s labor force to cloth production, using the labor-only process.1 When the switch is complete, the world economy is at b, where all of England’s cloth is used in Portuguese wine production. In general, b can be to the right or left of the vertical axis. Further cloth at the expense of wine requires the use of labor plus Portuguese wine in English cloth production. On the way to b, England’s labor is gradually switched from the labor-only to the labor plus wine process for making cloth. Meanwhile,
ac. The feasible set of world outputs is bounded by
nothing has happened to the labor allocation in Portugal where wine requires labor and cloth. The story is reversed, starting at e where only cloth is produced – unsustainable, as the world is short of the wine needed to sustain England’s cloth sector. From there to d (which may or may not be on the axis) Portuguese labor is switched into labor-only wine production. From d to c, labor is reassigned to Portugal’s labor plus cloth process for making wine. The coordinates of c thus measure England’s cloth output using its own labor and some Portuguese wine, and Portugal’s wine output using its own labor and some English cloth. These are net outputs available for world consumption.
