Question

1. Working with Numbers and Graphs Q1 Suppose that two economies, named Arcardia and Euphoria, can use their resources to produce good X, good Y, or a combination of both. The following table shows the four different combinations of the two goods each country can produce. Combinations A B C D Arcardia Euphoria Good X Good Y Good X Good Y 2400 6400 144 240 460 120 48 480 280 240 0 7200 360 Arcardia has a comparative advantage in the production of good , and Euphoria has a comparative advantage in the production of good . Which of the following terms of trade would allow both Arcardia and Euphoria to gain from trade? Check all that apply. 1/2 unit of good X per unit of good Y O2 units of good X per unit of good Y 3/5 unit of good X per unit of good Y 5/4 units of good X per unit of good Y

Answer 1

Arcadia's opportunity cost of producing good X is = 720/240 = 3 units of good Y and Euphoria's opportunity cost of producing good X is 360/640=0.56 units of good X. Because Euphoria has a lower opportunity cost for the production of good X. Therefore,Arcadia has a comparative advantage in the production of good Y and Euphoria has a comparative advantage in the production of good X.

Arcadia and Euphoria both countries gain from trade , when the terms of trade lie between 1/3 units of good X per unit of good Y and 1/0.56 units of good X per unit of good Y.

Because the terms of trade 1/2 unit of good X per unit of good Y , 3/5 units of good X per unit Y and 5/4 units of good X per unit of good Y lies in the above range , so these terms of trade would both countries to gain from trade. Hence, option(A), (C) and (D) are correct.

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 good X i.e Euphoria will produce 640 units of good X  And the country that produces good Y i,e Arcadia will produce 720 units of good Y.

Suppose the country that produces good X trades 320 units of good X to the other country in exchange for 320 units of good Y.

		ARCADIA		EUPHORIA
		Good X (Units)	Good Y (units)	Good X (Units)	Good Y (Units)
Without trade	Production & Consumption	144	240	280	240
With Trade	Production	0	720	640	0
	Trade action	Import 320	Export 320	Export 320	Import 320
	Consumption	320	(720-320)=400	(640-320)=320	320
Gains from trade	Increase in consumption	(320-144)=176	(400-240)=160	(320-280)=40	(320-240)=80