Question

Consider two neighboring island countries called Euphoria and Bellissima. They each have 4 million labor hours available per week that they can use to produce rye, jeans, or a combination of both. The following table shows the amount of rye or jeans that can be produced using 1 hour of labor 

Rye eans Country Bushels per hour of labor) (Pairs per hour of labor) Euphoria Bellissima 5 20 16 

Initially, suppose Bellissima uses 1 million hours of labor per week to produce rye and 3 million hours per week to produce jeans, while Euphoria uses 3 million hours of labor per week to produce rye and 1 million hours per week to produce jeans. Consequently, Euphoria produces 15 million bushels of rye and 20 million pairs of jeans, and Bellissima produces 8 million bushels of rye and 48 million pairs of jeans. Assume there are no other countries willing to trade goods, so, in the absence of trade between these two countries, each country consumes the amount of rye and jeans it produces 

Euphoria's opportunity cost of producing 1 bushel of rye is _______  of jeans, and Bellissima's opportunity cost of producing 1 bushel of rye is _______  of jeans. Therefore, _______  has a comparative advantage in the production of rye, and has a comparative advantage in the production of jeans. 

Suppose that each country completely specializes in the production of the good in which it has a comparative advantage, producing only that good. 

In this case, the country that produces rye will produce million bushels per week, and the country that produces jeans will produce million pairs per week. In the following table, enter each country's production decision on the third row of the table (marked "Production") 

Suppose the country that produces rye trades 18 million bushels of rye to the other country in exchange for 54 million pairs of jeans.

Answer 1

Euphoria:

5 bushels of Rye = 20 pairs of Jeans

1 bushel of Rye = 20/5 = 4 pairs of Jeans

Opportunity cost of producing 1 bushel of Rye is 4 pairs of Jeans.

Belissima:

8 bushels of Rye = 16 pairs of Jeans

1 bushel of Rye = 16/8 = 2 pairs of Jeans

Opportunity cost of producing 1 bushel of Rye is 2 pairs of Jeans.

A country has a comparative advantage in producing that good if the opportunity cost of producing that good is lower in that country as compared to another country.

Opportunity cost of producing 1 bushel of Rye is lower in Belissima so, Belissima has a comparative advantage in Rye and Euphoria has a comparative advantage in Jeans.

When Belissima uses 4 million hours of labor to produce Rye then it is able to produce 4 million X 8 = 32 million bushels of Rye

When Euphoria uses 4 million hours of labor to produce Jeans then it is able to produce 4 million X 20 = 80 million pairs of Jeans

Increase in production of Rye = 32 million - 23 million = 9 million

Increase in production of Jeans = 80 million - 68 million = 12 million

Answer 2

It is a one factor model where production differences arise solely due to labour productivity of two countries.

Here we summarise the input and output -

Country	Labour hrs to produce 1 bushels of rye	Labour hrs. to produce 1 pair of jeans
Felicidad	1/5	1/20
Bellissima	1/8	1/16

Therefore the opportunity cost of producing 1 bushel rye is -

i.  Felicidad - (1/5) / (1/20) = 4 pair of jeans

ii. Bellissima - (1/8) / (1/16) = 2 pair of jeans - less cost

and, the opportunity cost of producing 1 pair of jeans is -

i.  Felicidad - (1/20) / (1/5) = 0.25 bushels - less cost

ii. Bellissima - (1/16) / (1/8) = 0.5 bushels

Therefore Felicidad has a comparative advantage in producing jeans and Bellissima has a comparative advantage in producing rye.

If each country specialises in producing good in which it has comparative advantage then,

For Felicidad, if it takes 1 million labour hours to produce 20 million pair of jeans,

Then, in 4 million labour hours ,4 x 20 = 80 million pairs of jeans are produced.

Similarly, for Bellissima, if it takes 1 million labour hours to produce 8 million bushels of rye,

then, in 4 million labour hours,4 x 8 = 32 million bushels are produced.

Therefore, Felicidad will produce 80 million pairs of jeans per week and Bellissima will produce 32 million bushels of rye per week.

When the two countries did not specialise the total production of bushels of rye per week was 23 million and the total production of jeans per week was 68 million.

Because of specialisation the total production of rye has increased by 32-23= 9 million bushels of rye per week and the total production of jeans has increased by 80-68 = 12 millions of jeans per week

	Felicidad (in millions)		Bellissima ( in millions)
Without Trade	Rye	Jeans	Rye	Jeans
Production	15	20	8	48
Consumption 1	15	20	8	48
With Trade Production	0	80	32	0
Trade Action	Imports 18 bushels	Exports 54 pairs	Exports 18 bushels	Imports 54 pairs
Consumption 2	18	80- 54 = 26	32 - 18 = 14	54
Gains from Trade - Increase in Consumption	18-15= +3	26-20= +6	14-8= + 6	54-48 = +6