Question

3. Gains from trade Consider two neighbouring island countries called Dolorium and Bellissima. They each have 4 million labour hours available per week 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 one hour of labour. Country Dolorium Corn (Bushels per hour of labour) 5 Jeans (Pairs per hour of labour) 20 Bellissima 8 16

Answer 1

Dolorium's opportunity cost of producing 1 bushel of corn is 20/5=4 pair of jeans and Bellissima's opportunity cost of producing 1 bushels of corn is 16/8=2 pair of jean. Because Bellissima has a lower opportunity cost for the production of corn. Therefore, Bellissima has a comparative advantage in the production of corn and Dolorium 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 Bellissima will produce (4)(8) = 32 million bushels per week And the country that produces jeans i.e Dolorium will produce 4(20)=80 million pairs per week.

Suppose the country that produces corn trades 18 million bushels of corn to the other country in exchange for 54 million pairs of jeans.

		DOLORIUM		BELLISSIMA
		Corn (milions of bushels)	Jeans (Millions of pairs)	Corn (Millions of bushels)	Jeans (Millions of pairs)
Without trade	Production	15	20	8	48
	Consumption	15	20	8	48
With Trade	Production	0	80	32	0
	Trade action	Import 18	Export 54	Export 18	Import 54
	Consumption	18	(80-54)=26	(32-18)=14	54
Gains from trade	Increase in consumption	(18-15)=3	(26-20)=6	(14-8)=6	(54-48)=6

When the two countries did not specialize ,the total production of corn was 23 million bushels per week and the total production of jeans was 68  millions pairs per week. Because of specialization ,the total production of corn was 32 million bushels per week and total production of jeans was 80 million pairs per week. This implies that because of specialization , total production of corn has increased by (32-23)=9 million bushels per week and total production of jeans has increased by (80-68)=12 million pairs per week.