In: Economics
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 corn, jeans, or a combination of both. The following table shows the amount of corn or jeans that can be produced using 1 hour of labor.
Country | Corn | Jeans |
---|---|---|
(Bushels per hour of labor) | (Pairs per hour of labor) | |
Euphoria | 8 | 32 |
Arcadia | 12 | 24 |
Initially, suppose Arcadia uses 1 million hours of labor per month to produce corn and 3 million hours per month to produce jeans, while Euphoria uses 3 million hours of labor per month to produce corn and 1 million hours per month to produce jeans. Consequently, Euphoria produces 24 million bushels of corn and 32 million pairs of jeans, and Arcadia produces 12 million bushels of corn and 72 million pairs of jeans. 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 corn and jeans it produces.
Euphoria's opportunity cost of producing 1 bushel of corn is --------of jeans, and Arcadia's opportunity cost of producing 1 bushel of corn is of--------- jeans. Therefore, ------------- has a comparative advantage in the production of corn, and ------------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 will produce-----------million bushels per month, and the country that produces jeans will produce-------------million pairs 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 corn trades 26 million bushels of corn to the other country in exchange for 78 million pairs of jeans.
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 corn was 36 million bushels per month, and the total production of jeans was 104 million pairs per month. Because of specialization, the total production of corn has increased by-----------million bushels per month, and the total production of jeans has increased by-----------million pairs per month.
Because the two countries produce more corn and more jeans 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").
Euphoria |
Arcadia |
|||
---|---|---|---|---|
Corn | Jeans | Corn | Jeans | |
(Millions of bushels) | (Millions of pairs) | (Millions of bushels) | (Millions of pairs) | |
Without Trade | ||||
Production | 24 | 32 | 12 | 72 |
Consumption | 24 | 32 | 12 | 72 |
With Trade | ||||
Production | ||||
Trade action | ||||
Consumption | ||||
Gains from Trade | ||||
Increase in Consumption |
Europhia’s opportunity cost of producing one bushel of corn is = 32/8 = 4 jeans
Arcadia’s opportunity cost of producing one bushel of corn is = 24/12 = 2 jeans
Therefore, Arcadia has a comparative advantage in the production of corn and Europhia has a comparative advantage in the production of jeans.
When both the countries specialises in the products in which they have comparative advantage,
Europhia will produce 32*4 million = 128 million jeans
Arcadia will produce 12* 4 million = 48 million bushels of corn.
If Arcadia trade 26 million bushels of corn then Europhia will import 26 million bushels of corn and Arcadia will export 26 million bushels of corn. And if Europhia trade 78 million jeans then Arcadia will import 78 million jeans and Europhia will export 78 million jeans.
The final consumption for Arcadia will be 22 million bushels of corn and 78 million jeans.
The final consumption for Europhia will be 50 million jeans and 26 million bushels of corn.
Before specialisation the total production of corn was 36 million bushels of corn and after specialisation the total production of corn is 48 million bushels of corn , so there is a increase of 12 million bushels of corn after specialisation.
Before specialisation the total production of jeans was 104 million pairs and after specialisation the total production of jeans is 128 million pairs so there is the increase of 24 million pairs of jeans after specialization.
Initially Arcadia used to consume 12 million bushels of corn and 72 million pairs of jeans and after trade Arcadia is able to consume 22 million bushels of corn and 78 million pairs of jeans, so we can see that Arcadia has extra 10 million bushels of corn and 6 million pairs of jeans to consume
Initially Europhia used to consume 24 million bushels of corn and 32 million pairs of jeans and after trade Arcadia is able to consume 26 million bushels of corn and 50 million pairs of jeans, so we can see that Arcadia has extra 8 million bushels of corn and 18 million pairs of jeans to consume