Calculating the Price Using a Production Possibilities Curve And Understanding the Trading Relationship

The Production Possibilities Curves (PPC) for countries A and B are shown in the following diagram.

Price Calculations for Country A

The price of shoes for country A:

100 pairs of shoes = 300 loaves of bread, or 1 pair of shoes = 3 loaves of bread.

The diagram shows that 300 loaves of bread can be exchanged for 100 pairs of shoes, which can be reduced to a 3 to 1 relationship. This is the price of shoes.

The price of bread for country A:

300 loaves of bread = 100 pairs of shoes, or 3 loaves of bread = 1 pair of shoes, or 1 loaf of bread = 1/3 (one third) of a pair of shoes.

In country A, 300 loaves of bread can be exchanged for 100 pairs of shoes, or 1 loaf of bread can be exchanged for 1/3 of a pair of shoes. This is the actual price of the items.

 Price Calculations for Country B

50 pairs of shoes = 250 loaves of bread, or 1 pair of shoes = 5 loaves of bread.

In Country B, 50 pairs of shoes can be exchanged for 250 loaves of bread, or 1 pair of shoes can be exchanged for 5 loaves of bread. This is the actual price for the items.

The price of bread for country B:

250 loaves of bread = 50 pairs of shoes, or 5 loaves of bread = 1 pair of shoes, or1 loaf of bread = 1/5 (one-fifth) pair of shoes. In Country B, 250 loaves of bread can be exchanged for 50 pairs of shoes, or 1 loaf of bread can be exchanged for 1/5 of a pair of shoes.

This is the actual price for the items.

Understanding the Trading Relationship Between Two Countries

The example shows that if two countries trade between themselves and each produces the same two products, then if country A has an advantage in producing one item, country B must have an advantage in manufacturing the second item. If one country had an advantage in producing both items, then a trading relationship wouldn’t exist.