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    Production possibilities curve and points

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    1. Why does a production possibilities curve bow out rather than forming a straight line sloping downward from left to right?

    2. Out of all of the possible production points along a production possibilities curve, which one of those points does a nation select and why?

    3. What does the Heckscher-Ohlin Theory say about what determines the trade patterns between countries?

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    Solution Preview

    1) A production possibilities curve bows out rather than forming a straight line sloping downward from left to right because decreasing returns to scale. Assume there are just two goods for a country and think of the extreme example where they devote themselves to producing just one of the two goods. In order to get the last few units produced, they would have to tap every available capital and labor resource. The more they produce, the more inefficient they become at producing that good. Now if they switched to just producing the other good the same would happen. Each additional parcel of land would likely get more and more expensive to convert to wheat fields for instance as land gets scarcer. Now think of a more neutral mix such as 50% wheat and 50% cars. This would have greater efficiencies since the country likely has certain efficiencies in each industry. They have ...

    Solution Summary

    The Solution discusses the Heckscher-Ohlin Theory as it applies to comparative advantage and international trade.