CHAPTER 16 • General Equilibrium and Economic Efficiency 619 to produce a pound of cheese and hours to produce a gallon of wine The production relationships are summarized in Table 16.3.6 Holland has a comparative advantage over Italy in producing cheese Holland’s cost of cheese production (in terms of hours of labor used) is half its cost of producing wine, whereas Italy’s cost of producing cheese is twice its cost of producing wine Likewise, Italy has a comparative advantage in producing wine, which it can produce at half the cost at which it can produce cheese WHAT HAPPENS WHEN NATIONS TRADE The comparative advantage of each country determines what happens when they trade The outcome will depend on the price of each good relative to the other when trade occurs To see how this might work, suppose that with trade, one gallon of wine sells for the same price as one pound of cheese in both Holland and Italy Suppose also that because there is full employment in both countries, the only way to increase production of wine is to take labor out of the production of cheese, and vice versa Without trade, Holland could, with 24 hours of labor input, produce 24 pounds of cheese, 12 gallons of wine, or a combination of the two, such as 18 pounds of cheese and gallons of wine But Holland can better For every hour of labor, Holland can produce pound of cheese, which it can trade for gallon of wine; if the wine were produced at home, hours of labor would be required It is, therefore, in Holland’s interest to specialize in the production of cheese, which it will export to Italy in exchange for wine If, for example, Holland produced 24 pounds of cheese and traded 6, it would be able to consume 18 pounds of cheese and gallons of wine—a definite improvement over the 18 pounds of cheese and gallons of wine available in the absence of trade Italy is also better off with trade Note that without trade, Italy can, with the same 24 hours of labor input, produce pounds of cheese, gallons of wine, or a combination of the two, such as pounds of cheese and gallons of wine On the other hand, with every hour of labor, Italy can produce one-third of a gallon of wine, which it can trade for one-third of a pound of cheese If it produced cheese at home, twice as much time would be involved Specialization in wine production, therefore, is advantageous for Italy Suppose that Italy produced gallons of wine and traded 6; in that case, it would be able to consume pounds of cheese and gallons of wine—likewise an improvement over the pounds of cheese and gallons of wine available without trade An Expanded Production Possibilities Frontier When there is comparative advantage, international trade has the effect of allowing a country to consume outside its production possibilities frontier This can be seen graphically in Figure 16.12, which shows a production possibilities frontier for Holland Suppose initially that Holland has been prevented from trading with Italy because of a protectionist trade barrier What is the outcome of the competitive process in Holland? Production is at point A, on indifference curve U1, where the MRT and the pre-trade price of wine is twice the price of cheese If Holland were able to trade, it would want to export pounds of cheese in exchange for gallon of wine This example is based on “World Trade: Jousting for Advantage,” The Economist (September 22, 1990): 5–40