Question

  

3. Gains from trade Consider two neighboring island countries called Felicidad and Contente. They each have 4 million labor hours available per month that they can use to produce corn, jeans, or a combination of both. The following table shows the amount of corn or jeans that can be produced using 1 hour of labor. Country Corn Jeans (Bushels per hour of labor) (Pairs per hour of labor) Felicidad 4 16 Contente 5 10 Initially, suppose Contente uses 1 million hours of labor per month to produce corn and 3 million hours per month to produce jeans, while Felicidad uses 3 million hours of labor per month to produce corn and 1 million hours per month to produce jeans. Consequently, Felicidad produces 12 million bushels of corn and 16 million pairs of jeans, and Contente produces 5 million bushels of corn and 30 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 corn and jeans it produces. Felicidad's opportunity cost of producing 1 bushel of corn is   of jeans, and Contente's opportunity cost of producing 1 bushel of corn is   of jeans. Therefore,   has a comparative advantage in the production of corn, 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 corn will produce million bushels per month, and the country that produces jeans will produce million pairs per month. In the following table, enter each country's production decision on the third row of the table (marked "Production"). Suppose the country that produces corn trades 13 million bushels of corn to the other country in exchange for 39 million pairs of jeans. In the following table, select the amount of each good that each country exports and imports in the boxes across the row marked "Trade Action," and enter each country's final consumption of each good on the line marked "Consumption." When the two countries did not specialize, the total production of corn was 17 million bushels per month, and the total production of jeans was 46 million pairs per month. Because of specialization, the total production of corn has increased by million bushels per month, and the total production of jeans has increased by million pairs per month. Because the two countries produce more corn and more jeans under specialization, each country is able to gain from trade. Calculate the gains from trade—that is, the amount by which each country has increased its consumption of each good relative to the first row of the table. In the following table, enter this difference in the boxes across the last row (marked "Increase in Consumption"). Felicidad Contente Corn Jeans Corn Jeans (Millions of bushels) (Millions of pairs) (Millions of bushels) (Millions of pairs) Without Trade Production 12 16 5 30 Consumption 12 16 5 30 With Trade Production Trade action             Consumption Gains from Trade Increase in Consumption

Answer 1

Felicidad's opportunity cost of producing 1 bushel of corn is 16/4 = 4 pairs of jeans and Contente's opportunity cost of producing 1 bushel of corn is 10/5 =2 pairs of jeans. Because Contente has a lower opportunity cost for the production of corn. Therefore, Contente has a comparative advantage in the production of corn and Felicidad 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 corn i.e Contente will produce (4)(5) = 20 million bushels per month . And the country that produces jeans i.e Felicidad will produce 4(16)=64 million pairs per month.

Suppose the country that produces corn trades 13 million bushels of corn to the other country in exchange for 39 million pairs of jeans.

		FELICIDAD		CONTENTE
		Corn (milions of bushels)	Jeans (Millions of pairs)	Corn (Millions of bushels)	Jeans (Millions of pairs)
Without trade	Production	12	16	5	30
	Consumption	12	16	5	30
With Trade	Production	0	64	20	0
	Trade action	Import 13	Export 39	Export 13	Import 39
	Consumption	13	(64-39)= 25	(20-13)=7	39
Gains from trade	Increase in consumption	(13-12)=1	(25-16)=9	(7-5)=2	(39-30)=9

When the two countries did not specialize ,the total production of corn was 17 million bushels per month and the total production of jeans was 46 millions pairs per month. Because of specialization ,the total production of corn was 20 million bushels per month and total production of jeans was 64 million pair per month. This implies that because of specialization , total production of corn has increased by (20-17)=3 million bushels per month and total production of jeans has increased by (64-46)=18 million pairs per month.