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Chapter 1: Introductory Trade Issues: History, Institutions, and Legal Framework
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Chapter 1: Introductory Trade Issues: History, Institutions, and Legal Framework
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- Section 1: The International Economy and International Economics
- Section 2: Understanding Tariffs
- Section 3: Recent Trade Controversies
- Section 4: The Great Depression, Smoot-Hawley, and the Reciprocal Trade Agreements Act (RTAA)
- Section 5: The General Agreement on Tariffs and Trade (GATT)
- Section 6: The Uruguay Round
- Section 7: The World Trade Organization
- Section 8: Appendix A: Selected U.S. Tariffs—2009
- Section 9: Appendix B: Bound versus Applied Tariffs
Chapter 1: Introductory Trade Issues: History, Institutions, and Legal Framework
- General Agreement on Tariffs and Trade (GATT)
- An international agreement among countries, established in 1948, promoting trade liberalization through the reduction of tariff rates and other barriers to trade until its conversion to the WTO in 1995.
- Uruguay Round
- The eighth and last round of GATT trade liberalization negotiations that substantially expanded the number and scope of trade liberalization agreements and established the WTO.
- World Trade Organization (WTO)
- An international agency whose purpose is to monitor and enforce the Uruguay Round trade liberalization agreements and to promote continuing liberalizing initiatives with continuing rounds of negotiation.
- most-favored nation (MFN)
- The nondiscriminatory treatment toward identical or highly substitutable goods coming from two different countries.
- national treatment
- The nondiscriminatory treatment of identical or highly substitutable domestically produced goods with foreign goods once the foreign products have cleared customs.
- antidumping laws
- Laws that provide protection to domestic import-competing firms that can show that foreign imported products are being “dumped” in the domestic market.
- antisubsidy laws
- Laws that provide protection to domestic import-competing firms that can show that foreign imported products are being directly subsidized by the foreign government.
- safeguard laws (aka escape clauses)
- Laws that provide protection to domestic import-competing firms that suffer a surge of imports.
- tariffication
- A process of converting import quotas to import tariffs. WTO countries agreed to tariffication for all commodities in the Uruguay Round Agreement.
- tariff-rate quota
- a low tariff set on a fixed quota of imports and a high tariff set on any imports that occur over that quota.
Chapter 2: The Ricardian Theory of Comparative Advantage
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Chapter 2: The Ricardian Theory of Comparative Advantage
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- Section 1: The Reasons for Trade
- Section 2: The Theory of Comparative Advantage: Overview
- Section 3: Ricardian Model Assumptions
- Section 4: The Ricardian Model Production Possibility Frontier
- Section 5: Definitions: Absolute and Comparative Advantage
- Section 6: A Ricardian Numerical Example
- Section 7: Relationship between Prices and Wages
- Section 8: Deriving the Autarky Terms of Trade
- Section 9: The Motivation for International Trade and Specialization
- Section 10: Welfare Effects of Free Trade: Real Wage Effects
- Section 11: The Welfare Effects of Free Trade: Aggregate Effects
- Section 12: Appendix: Robert Torrens on Comparative Advantage
Chapter 2: The Ricardian Theory of Comparative Advantage
- comparative advantage
- A country has a comparative advantage when it can produce a good at a lower opportunity cost than another country; alternatively, when the relative productivities between goods compared with another country are the highest.
- terms of trade
- The amount of one good traded per unit of another in a mutually voluntary exchange. Often expressed as a ratio of prices and measured as a ratio of units; for example, pounds of cheese per gallon of wine.
- homogeneous
- Goods, or production factors, that are identical and thus perfectly substitutable in consumption, or production.
- autarky
- The situation in which a country does not trade with the rest of the world.
- unit labor requirement
- The quantity of labor needed to produce one unit of a good.
- exogenous variable
- A variable whose value is determined external to the model and whose value is known to the agents in the model. In the Ricardian model, the unit labor requirements and the labor endowment are exogenous.
- endogenous variable
- A variable whose value is determined as an outcome of, or solution to, the model. In the Ricardian model, the allocation of workers to production, the quantities of the goods produced, and the terms of trade are endogenous.
- production possibility frontier (PPF)
- The set of all output combinations that could be produced in a country when all the labor inputs are fully employed. In the Ricardian model, the PPF is linear.
- labor productivity
- The quantity of a good that can be produced per unit of labor input. It is the reciprocal of the unit labor requirement.
- absolute advantage
- A country has an absolute advantage in the production of a good if it can produce the good at a lower labor cost and if labor productivity in the good is higher than in another country.
- opportunity cost
- The value or quantity of something that must be given up to obtain something else. In the Ricardian model, opportunity cost is the amount of a good that must be given up to produce one more unit of another good.
- real wage
- The quantity of a good that can be purchased per unit of work. Real wage is a measure of the purchasing power of a wage and is an effective measure of well-being.
Chapter 3: The Pure Exchange Model of Trade
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Chapter 3: The Pure Exchange Model of Trade
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Chapter 3: The Pure Exchange Model of Trade
- income redistribution
- Occurs when some individuals gain income while others lose or when individuals gain and lose income shares of total income.
- terms of trade
- The amount of one good traded per unit of another in a mutually voluntary exchange. Often expressed as a ratio of prices.
- mutually voluntary exchange
- A trade of one item for another chosen willingly (i.e., without coercion) by both individuals in a market.
- monopoly
- An individual or firm that is the sole seller of a product in a market.
- monopsony
- An individual or firm that is the sole buyer of a product in a market.
- economic efficiency
- The extent to which economic resources are transformed into products generating utility to consumers. Efficiency improves whenever greater output occurs per unit of input or when more satisfying consumption bundles are obtained.
Chapter 4: Factor Mobility and Income Redistribution
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Chapter 4: Factor Mobility and Income Redistribution
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- Section 1: Factor Mobility Overview
- Section 2: Domestic Factor Mobility
- Section 3: Time and Factor Mobility
- Section 4: Immobile Factor Model Overview and Assumptions
- Section 5: The Production Possibility Frontier in the Immobile Factor Model
- Section 6: Autarky Equilibrium in the Immobile Factor Model
- Section 7: Depicting a Free Trade Equilibrium in the Immobile Factor Model
- Section 8: Effect of Trade on Real Wages
- Section 9: Intuition of Real Wage Effects
- Section 10: Interpreting the Welfare Effects
- Section 11: Aggregate Welfare Effects of Free Trade in the Immobile Factor Model
Chapter 4: Factor Mobility and Income Redistribution
- factor mobility
- The ability to move factors of production—labor, capital, or land—out of one production process and into another.
- domestic factor mobility
- When productive factors like labor, capital, land, natural resources, and so on can be reallocated across sectors within a domestic economy.
- immobile factor model
- A standard Ricardian model with one variation in its assumptions, namely, that labor, the sole factor of production, is immobile between industries within a country.
- free and costless mobility
- Factors that can be moved by their owners to another production process without impediment and without incurring any adjustment costs.
Chapter 5: The Heckscher-Ohlin (Factor Proportions) Model
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Chapter 5: The Heckscher-Ohlin (Factor Proportions) Model
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- Section 1: Chapter Overview
- Section 2: Heckscher-Ohlin Model Assumptions
- Section 3: The Production Possibility Frontier (Fixed Proportions)
- Section 4: The Rybczynski Theorem
- Section 5: The Magnification Effect for Quantities
- Section 6: The Stolper-Samuelson Theorem
- Section 7: The Magnification Effect for Prices
- Section 8: The Production Possibility Frontier (Variable Proportions)
- Section 9: The Heckscher-Ohlin Theorem
- Section 10: Depicting a Free Trade Equilibrium in the Heckscher-Ohlin Model
- Section 11: National Welfare Effects of Free Trade in the Heckscher-Ohlin Model
- Section 12: The Distributive Effects of Free Trade in the Heckscher-Ohlin Model
- Section 13: The Compensation Principle
- Section 14: Factor-Price Equalization
- Section 15: The Specific Factor Model: Overview
- Section 16: The Specific Factor Model
- Section 17: Dynamic Income Redistribution and Trade
Chapter 5: The Heckscher-Ohlin (Factor Proportions) Model
- capital-labor ratio
- The ratio of the quantity of capital to the quantity of labor used in a production process.
- capital intensive
- An industry is capital intensive relative to another industry if it has a higher capital-labor ratio in the production process.
- labor intensive
- An industry is labor intensive relative to another industry if it has a higher labor-capital ratio in the production process.
- capital abundant
- A country is capital abundant relative to another country if it has a higher capital endowment per labor endowment than the other country.
- labor abundant
- A country is labor abundant relative to another country if it has a higher labor endowment per capital endowment than the other country.
- Stolper-Samuelson theorem
- A theorem that specifies how changes in output prices affect factor prices in the H-O model. It states that an increase in the price of a good will cause an increase in the price of the factor used intensively in that industry and a decrease in the price of the other factor.
- Rybczynski theorem
- A theorem that specifies how changes in endowments affect production levels in the H-O model. It states that an increase in a country’s endowment of a factor will cause an increase in the output of the good that uses that factor intensively and a decrease in the output of the other good.
- labor constraint
- A relationship showing that the sum of the labor used in all industries cannot exceed total labor endowment in the economy.
- labor endowment
- The total amount of labor resources available to work in an economy during some period of time.
- capital constraint
- A relationship showing that the sum of the capital used in all industries cannot exceed total capital endowment in the economy.
- capital endowment
- The total amount of capital resources available to work in an economy during some period of time.
- magnification effect for quantities
- A relationship in the H-O model that specifies the magnitude of output changes in response to changes in the factor endowments.
- magnification effect for prices
- A relationship in the H-O model that specifies the magnitude of factor price changes in response to changes in the output prices. It is used to identify the real wage and real rent effects of output price changes.
- Heckscher-Ohlin (H-O) theorem
- A theorem that predicts the pattern of trade in the H-O model. It states that the capital-abundant country will export the capital-intensive good and the labor-abundant country will export the labor-intensive good.
- value of the marginal product
- The increment in revenue that a firm will obtain by adding another unit of labor to its production process.
Chapter 6: Economies of Scale and International Trade
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Chapter 6: Economies of Scale and International Trade
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- Section 1: Chapter Overview
- Section 2: Economies of Scale and Returns to Scale
- Section 3: Gains from Trade with Economies of Scale: A Simple Explanation
- Section 4: Monopolistic Competition
- Section 5: Model Assumptions: Monopolistic Competition
- Section 6: The Effects of Trade in a Monopolistically Competitive Industry
- Section 7: The Costs and Benefits of Free Trade under Monopolistic Competition
Chapter 6: Economies of Scale and International Trade
- economies of scale
- The feature of many production processes in which the per-unit cost of producing a product falls as the scale of production rises.
- increasing returns to scale
- The feature of many production processes in which the productivity of a product increases as the scale of production rises.
- monopolistic competition
- A market structure that is a cross between the two extremes of perfect competition and monopoly.
- intraindustry trade
- Trade between countries that occurs within the same industry; for example, when a country exports and imports automobiles.
Chapter 7: Trade Policy Effects with Perfectly Competitive Markets
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Chapter 7: Trade Policy Effects with Perfectly Competitive Markets
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- Section 1: Basic Assumptions of the Partial Equilibrium Model
- Section 2: Depicting a Free Trade Equilibrium: Large and Small Country Cases
- Section 3: The Welfare Effects of Trade Policies: Partial Equilibrium
- Section 4: Import Tariffs: Large Country Price Effects
- Section 5: Import Tariffs: Large Country Welfare Effects
- Section 6: The Optimal Tariff
- Section 7: Import Tariffs: Small Country Price Effects
- Section 8: Import Tariffs: Small Country Welfare Effects
- Section 9: Retaliation and Trade Wars
- Section 10: Import Quotas: Large Country Price Effects
- Section 11: Administration of an Import Quota
- Section 12: Import Quota: Large Country Welfare Effects
- Section 13: Import Quota: Small Country Price Effects
- Section 14: Import Quota: Small Country Welfare Effects
- Section 15: The Choice between Import Tariffs and Quotas
- Section 16: Export Subsidies: Large Country Price Effects
- Section 17: Export Subsidies: Large Country Welfare Effects
- Section 18: Countervailing Duties
- Section 19: Voluntary Export Restraints (VERs): Large Country Price Effects
- Section 20: Administration of a Voluntary Export Restraint
- Section 21: Voluntary Export Restraints: Large Country Welfare Effects
- Section 22: Export Taxes: Large Country Price Effects
- Section 23: Export Taxes: Large Country Welfare Effects
Chapter 7: Trade Policy Effects with Perfectly Competitive Markets
- partial equilibrium
- An economic analysis in which the effects are examined only in the markets that are directly affected. Supply and demand curves for the market of interest are typically used in a partial equilibrium analysis.
- large country
- A country is large if any change in its trade volume for a product is sufficiently large to affect the price of that product in the rest of the world.
- small country
- A country is small if any change in its trade volume for a product is too small to have any effect on the price of that product in the rest of the world.
- export supply
- The quantity of a product a country would wish to export at a particular price. The export supply curve is the schedule of export supply at every potential price (usually prices above the country’s autarky price).
- import demand
- The quantity of a product a country would wish to import at a particular price. The import demand curve is the schedule of import demand at every potential price (usually prices below the country’s autarky price).
- consumer surplus
- The difference between what consumers are willing to pay for a unit of the good and the amount consumers actually do pay for the product.
- producer surplus
- The difference between what producers actually receive when selling a product and the amount they would be willing to accept for a unit of the good.
- monopsony power in trade
- Another term to describe a large importing country—that is, a country whose policy actions can affect international prices.
- maximum revenue tariff
- The tariff that achieves the highest government revenue.
- Nash equilibrium
- A game equilibrium in which every player is simultaneously maximizing his own profit given the choices being made by the other players.
- countervailing duty (CVD)
- A tariff on a product levied against a country that subsidizes the export of that product and that causes injury to the import-competing industry.
Chapter 8: Domestic Policies and International Trade
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Chapter 8: Domestic Policies and International Trade
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- Section 1: Chapter Overview
- Section 2: Domestic Production Subsidies
- Section 3: Production Subsidies as a Reason for Trade
- Section 4: Production Subsidy Effects in a Small Importing Country
- Section 5: Domestic Consumption Taxes
- Section 6: Consumption Taxes as a Reason for Trade
- Section 7: Consumption Tax Effects in a Small Importing Country
- Section 8: Equivalence of an Import Tariff with a Domestic (Consumption Tax plus Production Subsidy)
Chapter 8: Domestic Policies and International Trade
- trade policy
- Any policy that directly affects the flow of goods and services between countries, such as import tariffs, import quotas, voluntary export restraints, export taxes, and export subsidies.
- domestic policy
- Any type of tax or subsidy policy or any type of government regulation that targets the domestic behavior of firms or consumers.
- producer price
- The price received by producers, inclusive of any subsidies collected or taxes paid.
- consumer price
- The price paid by consumers, inclusive of any subsidies collected or taxes paid.
- domestic production subsidy
- A payment made by a government to firms in a particular industry based on output or production levels.
- domestic consumption tax
- A tax collected by a government on sales of a particular product.
Chapter 9: Trade Policies with Market Imperfections and Distortions
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Chapter 9: Trade Policies with Market Imperfections and Distortions
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- Section 1: Chapter Overview
- Section 2: Imperfections and Distortions Defined
- Section 3: The Theory of the Second Best
- Section 4: Unemployment and Trade Policy
- Section 5: The Infant Industry Argument and Dynamic Comparative Advantage
- Section 6: The Case of a Foreign Monopoly
- Section 7: Monopoly and Monopsony Power and Trade
- Section 8: Public Goods and National Security
- Section 9: Trade and the Environment
- Section 10: Economic Integration: Free Trade Areas, Trade Creation, and Trade Diversion
Chapter 9: Trade Policies with Market Imperfections and Distortions
- market imperfections or market distortions
- Any situation that deviates from the explicit or implicit assumptions of perfect competition.
- theory of the second best
- Describes the class of models that consider policy implications in the presence of market imperfections and distortions.
- first-best policy
- The policy that raises welfare to the highest level possible; with market imperfections or distortions present, the policy that most directly corrects the distortion or imperfection.
- monopsony power in trade
- Another term to describe a large importing country—that is, a country whose policy actions can affect international prices.
- monopoly power in trade
- Another term to describe a large exporting country—that is, a country whose policy actions can affect international prices.
- externalities
- Economic actions that have effects external to the market in which the action is taken.
- public goods
- Goods that are nonrival (the consumption or use of a good by one consumer does not diminish the usefulness of the good to another) and nonexcludable (once the good is provided, it is exceedingly costly to exclude nonpaying customers from using it).
- nonrivalry
- A situation in which consumption or use of a good by one consumer does not diminish the usefulness of the good to another.
- nonexcludability
- A situation in which once the good is provided, it is exceedingly costly to exclude nonpaying customers from using it.
- first-best equilibrium
- A market equilibrium that arises in the absence of any market imperfections or distortions; in other words, under the standard assumptions of perfect competition.
- second-best equilibrium
- A market equilibrium that arises in the presence of one or more market imperfections or distortions.
- second-best policy
- A policy whose best effect is inferior to another policy.
- infant industry
- An industry, most often in a developing country, that cannot compete in international markets in free trade but that, if given time to learn and develop, could be world-class efficient.
- economic integration
- Any type of arrangement in which countries agree to coordinate their trade, fiscal, or monetary policies.
- free trade area (FTA)
- A situation in which a group of countries agrees to eliminate tariffs among themselves but maintain their own external tariff on imports from the rest of the world.
- trade diversion
- A situation in which a free trade area diverts trade away from a more-efficient supplier outside the FTA toward a less-efficient supplier within the FTA.
- trade creation
- A situation in which a free trade area creates trade that would not have existed otherwise.
Chapter 10: Political Economy and International Trade
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Chapter 10: Political Economy and International Trade
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- Section 1: Chapter Overview
- Section 2: Some Features of a Democratic Society
- Section 3: The Economic Effects of Protection: An Example
- Section 4: The Consumers’ Lobbying Decision
- Section 5: The Producers’ Lobbying Decision
- Section 6: The Government’s Decision
- Section 7: The Lobbying Problem in a Democracy
Chapter 10: Political Economy and International Trade
- political economy
- A term used to describe the interaction between the economic system and the political system.
- representative democracy
- A political system where government officials are entrusted to take actions that are in the interests of their constituents. Periodic elections are the mechanism that makes it work.
- lobbying
- The activity wherein individual citizens voice their opinions to government officials about government policy actions.
- rent seeking
- A term used to describe the purposeful activity of seeking ways to shift profit or “rents” toward oneself or a favored group.
- directly unproductive profit-seeking (DUP) activity
- Any activity whose primary purpose is to shift benefits toward a particular group, often by influencing policy decisions. Although a DUP activity may indirectly benefit a producer of final consumer goods or services, it does not directly contribute to that production.
- free riding
- When someone enjoys the benefits of something without paying for it, especially when the product is a public good.
Chapter 11: Evaluating the Controversy between Free Trade and Protectionism
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Chapter 11: Evaluating the Controversy between Free Trade and Protectionism
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Chapter 11: Evaluating the Controversy between Free Trade and Protectionism
- lump-sum redistribution
- A redistribution of income that takes place after the free trade equilibrium is reached—that is, after all production and consumption decisions are made but before the actual consumption takes place.
- selected protection
- A trade policy that is appropriately selected so as to raise national welfare in a market containing market imperfections or distortions.
There are no key terms for this page.
The Ricardian Model Production Possibility Frontier
Learning Objective
-
Learn how the plot of the labor constraint yields the production possibility frontier.
Using the two production functions and the labor constraint, we can describe the production possibility frontier (PPF)production possibility frontier (PPF)The set of all output combinations that could be produced in a country when all the labor inputs are fully employed. In the Ricardian model, the PPF is linear.. First, note that the production functions can be rewritten as LC = aLC QC and LW = aLW QW. Plugging these values for LC and LW into the labor constraint yields the equation for the PPF:
This equation has three exogenous variables (aLC, aLW, and L) that we assume have known values and two endogenous variables (QC and QW) whose values must be solved for. The PPF equation is a linear equation—that is, it describes a line. With some algebraic manipulation, we can rewrite the PPF equation into the standard form for an equation of a line, generally written as y = mx + b, where y is the variable on the vertical axis, x is the variable on the horizontal axis, m is the slope of the line, and b is the y-intercept. The PPF equation can be rewritten as
We plot the PPF on the diagram in Figure 2.1, “Production Possibilities” with QC on the horizontal axis and QW on the vertical axis. The equation is easily plotted by following three steps.
Figure 2.1. Production Possibilities
-
Set QC = 0 and solve for QW. In this case, the solution is . This corresponds to the QW-intercept. It tells us the quantity of wine that the United States could produce if it devoted all of its labor force (L) to the production of wine.
-
Set QW = 0 and solve for QC. In this case, the solution is . This corresponds to the QC-intercept. It tells us the quantity of cheese that the United States could produce if it devoted all of its labor force (L) to the production of cheese.
-
Connect the two points with a straight line.
The straight downward-sloping line is the production possibility frontier. It describes all possible quantity combinations of wine and cheese that can be achieved by the U.S. economy. A movement along the curve represents a transfer of labor resources out of one industry and into another such that all labor remains employed.
Points inside the PPF are production possibilities but correspond to underemployment of labor resources. In fact, all production possibilities regardless of whether full employment is fulfilled are referred to as the production possibility set (PPS). The PPS is represented by all the points within and on the border of the red triangle in Figure 2.1, “Production Possibilities”.
Key Takeaways
-
The equation aLC QC + aLW QW = L is an equation of a line whose plot represents the country’s production possibility frontier (PPF).
-
A PPF is the combination of outputs of cheese and wine that the country can produce given a production technology (i.e., given that unit labor requirements are exogenous) and assuming all of its labor hours are employed.
-
A production possibility set (PPS) is the combination of outputs that a country can produce even if some of the labor is unemployed.
Exercises
-
Jeopardy Questions. As in the popular television game show, you are given an answer to a question and you must respond with the question. For example, if the answer is “a tax on imports,” then the correct question is “What is a tariff?”
-
The term describing the set of all output combinations that can be produced within an economy.
-
The term describing the set of all output combinations that can be produced within an economy with full employment of all available resources.
-
-
Suppose that the unit labor requirements for wine and cheese are aLC = 6 hrs./lb., aLW = 4 hrs./gal., respectively, and that total labor hours available for production are 60. What is the maximum output of cheese? What is the maximum output of wine?
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Suppose that the unit labor requirements for wine and cheese are aLC = 6 hrs./lb. and aLW = 4 hrs./gal., respectively, and that total labor hours available for production are 60. Plot the production possibility frontier.
Citation Information
APA Format:Suranovic, Steve., International Trade: Theory and Policy. Retrieved Jan 5, 2012 from http://www.flatworldknowledge.com/node/61960 .
MLA Format:Suranovic, Steve. International Trade: Theory and Policy. 1969 . Flat World Knowledge. 5 Jan, 2012. <http://www.flatworldknowledge.com/node/61960> .
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