Question

3. Gains from trade Consider two neighboring island countries called Felicidad and Arcadia. They each have 4 million labor hours available per week that they can use to produce jeans, rye, or a combination of both. The following table shows the amount of jeans or rye that can be produced using 1 hour of labor. Jeans (Pairs per hour of labor) Rye (Bushels per hour of labor) Country Felicidad Arcadia 12 Initially, suppose Arcadia uses 1 million hours of labor per week to produce jeans and 3 million hours per week to produce rye, while Felicidad uses 3 million hours of labor per week to produce jeans and 1 million hours per week to produce rye. Consequently, Felicidad produces 24 million pairs of jeans and 32 million bushels of rye, and Arcadia produces 12 million pairs of jeans and 72 million bushels of rye. 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 rye it produces. Felicidad's opportunity cost of producing 1 pair of jeans is of rye, and Arcadia's opportunity cost of producing 1 pair of jeans is of rye. Therefore, has a comparative advantage in the production of jeans, and has a comparative advantage in the production of rye. 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 rye will produce million bushels 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 jeans trades 26 million pairs of jeans to the other country in exchange for 78 million bushels of rye. 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 jeans was 36 million pairs per week, and the total production of rye was 104 million bushels per week. Because of specialization, the total production of jeans has increased by million pairs per week, and the total production of

Answer 1

Felicidad's opportunity cost of producing 1 pair of jeans is 32/8 = 4 bushel of rye and Arcadia's opportunity cost of producing 1 pair of jeans is 24/12 =2 bushel of rye. Because Arcadia has a lower opportunity cost for the production of jeans. Therefore, Arcadia has a comparative advantage in the production of jeans and Felicidad has a comparative advantage in the production of rye.

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 i.e Arcadia will produce (4)(12) = 48 million pairs per week And the country that produces rye i.e Felicidad will produce 4(32)=128 million bushels per week.

Suppose the country that produces corn trades 26 million pairs of jeans to the other country in exchange for 78 million bushels of rye.

		FELICIDAD		ARCADIA
		Jeans (millions of pairs)	Rye (Millions of bushels)	Jeans (Millions of pairs)	Rye (Millions of bushels)
Without trade	Production	24	32	12	72
	Consumption	24	32	12	72
With Trade	Production	0	128	48	0
	Trade action	Import 26	Export 78	Export 26	Import 78
	Consumption	26	(128-78)= 50	(48-26)=22	78
Gains from trade	Increase in consumption	(26-24)=2	(50-32)= 18	(22-12)=10	(78-72)=6

When the two countries did not specialize ,the total production of jeans was 36 million pairs per week and the total production of rye was 104 millions bushels per week. Because of specialization ,the total production of jeans was 48 million pairs per week and total production of rye was 128 million bushels per week.This implies that because of specialization , total production of jeans has increased by (48-36)=12 million pairs per week and total production of rye has increased by (128-104)=24 million bushels per week.