Question

3. Gains from trade Consider two neighboring island countries called Arcadia and Euphoria. They each have 4 million labor hours available per week that they can use to produce jeans, corn, or a combination of both. The following table shows the amount of jeans or corn that can be produced using 1 hour of labor Jeans Corn Country (Pairs per hour of labor) (Bushels per hour of labor) Arcadia Euphoria 8 16 20 Initially, suppose Arcadia uses 1 million hours of labor per week to produce jeans and 3 million hours per week to produce corn, while Euphoria uses 3 million hours of labor per week to produce jeans and 1 million hours per week to produce corn. Consequently, Arcadia produces 8 million pairs of jeans and 48 million bushels of corn, and Euphoria produces 15 million pairs of jeans and 20 million bushels of corn. 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 jeans and corn it produces. Arcadia's opportunity cost of producing 1 pair of jeans is of corn, and Euphoria's opportunity cost of producing 1 pair of jeans is of corn. Therefore, has a comparative advantage in the production of jeans, and has a comparative ▼ advantage in the production of corn. 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 jeans will produce million pairs per week, and the country that produces corn will produce million bushels per week.

Answer 1

Arcadia's opportunity cost of producing 1 pair of jeans = 16/8 = 2 bushels of corn

Euphoria's opportunity cost of producing 1 pair of jeans = 20/5 = 4 bushels of corn

Therefore, Arcadia has a comparative advantage in production of jeans and Euphoria has a comparative advantage in production of corn. (lower opportunity cost)

After complete specialization:

Jeans produced = 4 x 8 = 32 mn pairs

Corn produced = 4 x 20 = 80 mn bushels

Because of specialization, the total production of jeans has increased by 9 mn pairs per week , and the total production of corn has increased by 12 mn bushels per week.

	Arcadia		Euphoria
	Jeans	Corn	Jeans	Corn
Without trade
Production	8	48	15	20
Consumption	8	48	15	20
With trade
Production	32	0	0	80
Trade action	-18	54	18	-54
Consumption	14	54	18	26
Gains from trade
Increase in consumption	6	6	3	6

Increase in consumption = Consumption after trade - Consumption before trade