Figure 2.12 Production Possibilities Curves and Trade Suppose the world consists of two continents: South America and Europe They can each produce two goods: food and computers In this example, we assume that each continent has a linear production possibilities curve, as shown in Panels (a) and (b) South America has a comparative advantage in food production and Europe has a comparative advantage in computer production With free trade, the world can operate on the bowed-out curve GHI, shown in Panel (c) If the continents refuse to trade, the world will operate inside its production possibilities curve If, for example, each continent were to produce at the midpoint of its production possibilities curve, the world would produce 300 computers and 300 units of food per period at point Q If each continent were to specialize in the good in which it has a comparative advantage, world production could move to a point such as H, with more of both goods produced The world production possibilities curve assumes that resources are allocated between computer and food production based on comparative advantage Notice that, even with only two economies and the assumption of linear production possibilities curves for each, the combined curve still Attributed to Libby Rittenberg and Timothy Tregarthen Saylor URL: http://www.saylor.org/books/ Saylor.org 89