Question

3. Gains from trade

Consider two neighboring island countries called Euphoria and Arcadia. They each have 4 million labor hours available per month 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.

Country	Jeans	Corn
	(Pairs per hour of labor)	(Bushels per hour of labor)
Euphoria	5	20
Arcadia	8	16

Initially, suppose Arcadia uses 1 million hours of labor per month to produce jeans and 3 million hours per month to produce corn, while Euphoria uses 3 million hours of labor per month to produce jeans and 1 million hours per month to produce corn. Consequently, Euphoria produces 15 million pairs of jeans and 20 million bushels of corn, and Arcadia produces 8 million pairs of jeans and 48 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.

Euphoria's opportunity cost of producing 1 pair of jeans is ______ of corn, and Contente'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 month, and the country that produces corn will produce ____ million bushels per month.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 18 million pairs of jeans to the other country in exchange for 54 million bushels of corn.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 23 million pairs per month, and the total production of corn was 68 million bushels per month. Because of specialization, the total production of jeans has increased by _____ million pairs per month, and the total production of corn has increased by ______ million bushels per month.Because the two countries produce more jeans and more corn under specialization, each country is able to gain from trade.Calculate the gains from trade—that is, the amount by which each country has increased its consumption of each good relative to the first row of the table. In the following table, enter this difference in the boxes across the last row (marked “Increase in Consumption”).

Answer 1

Euphoria:

5 pairs of Jeans = 20 bushels of Corn

1 pair of Jeans = 20/5 = 4 bushels of Corn

The opportunity cost of producing 1 pair of jeans is 4 bushels of Corn.

Arcadia:

8 pairs of Jeans = 16 bushels of Corn

1 pair of Jeans = 2 pairsbushels of Corn

The opportunity cost of producing 1 pair of Jeans is 2 bushels of Corn.

A country has a comparative advantage in producing that good if the opportunity cost of producing that good is lower in that country as compared to another country.

The opportunity cost of producing 1 pair of Jeans is lower in Arcadia so, Arcadia has a comparative advantage in Jeans and Euphoria has a comparative advantage in Corn.

When Arcadia uses 4 million hours of labor to produce Jeans then it is able to produce 4 million X 8 = 32 million pairs of Jeans

When Euphoria uses 4 million hours of labor to produce Corn then it is able to produce 4 million X 20 = 80 million bushels of Corn

Total production of Jeans increased by 32 million - 23 million = 9 million

Total production of Corn increased by 80 million - 68 million = 12 million