Question

3. You and your neighbor are the only people in a world that produces only berries and squash. You do not engage in trade with each other. On your own, you can each produce the following per day:

	You		Neighbor
	Berries	Squash	Berries	Squash
Only gather berries	24 pounds	0 pounds	8 pounds	0 pounds
Only gather squash	0 pounds	12 pounds	0 pounds	8 pounds

Right now you each split your time between gathering the two products. You currently gather and consume 16 pounds of berries and 4 pounds of squash, while your neighbor is gathering and consuming 6 pounds of berries and 2 pounds of squash. Show (both graphically and numerically) how specialization and then trade with each other can make both of you better off. Who specializes in the production of each product? After specialization, what is an example of a trade that would be beneficial for both of you to make?

Answer 1

In the diagram below, we have shown the PPF for me and my neighbor. We have shown the consumption points without trade for me and my neighbor as A and B respectively.

Berries Berries PPF for me B PPF for neighbor 12 8 Squash Squash

Here, I have comparative advantage in production of berries while my neighbor have comparative advantage in the production of squash.

Terms of Trade will take place in the range of their respective autarky prices, 1 berries per unit of squash for my neighbor and 2 berries per unit of squash for me.

Suppose trade takes place at 1.5 berries per unit of squash,

Then, if I produce only 24 units of berries and consume 16 units while trade remaining 8 units of it, I will get 5.33 units of squash.

Similarly, if my neighbor produces only 8 units of squash and consume 2 units while trade remaining 6 units of it, he will get 9 units of berries.

Thus, both gains from trade.