Question

4. Gains from trade Consider two neighboring island countries called Contente 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 (Pairs per hour of labor) Corn (Bushels per hour of labor) Country Contente Euphoria 16 20 Initially, suppose Contente 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, Contente 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. Contente's opportunity cost of producing 1 pair of jeans is 2 bushels of corn, and Euphoria's opportunity cost of producing 1 pair of jeans is 4 bushels of corn. Therefore, Contente has a comparative advantage in the production of jeans, and Euphoria 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

	Jeans	Corn
Contente	8	16
Euphoria	5	20

Now, calculating the opportunity cost

	1 pair of Jeans	1 bushel of Corn
Contente	2 bushel of corn	0.5 pair of jeans
Euphoria	4 bushel of corn	0.25 pair of jeans

Contente's opportunity cost of producing 1 pair of jeans is 2 bushel of corn, Euphoria's opportunity cost of producing 1 pair of jeans is 4 bushel of corn. Therefore, Contente has a comparative advantage in the production of jeans, and Euphoria has a comparative advantage in 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 32 million pairs of jeans per week, and the country that produces corn will produce 80 million bushels per week.

When the two countries did not specialize, the total production of jeans was 23 million pairs per week, and the total production of corn was 68 million bushels per week. Because of specialization, the total production of jeans has increased by 9 million pairs per week, and the total production of corn has increased by 12 million bushels per week.

	Contente		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

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