Question

Gains from trade Consider two neighboring island countries called Felicidad 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) Felicidad 4 16 Arcadia 5 10 Initially, suppose Arcadia uses 1 million hours of labor per month to produce corn and 3 million hours per month to produce jeans, while Felicidad uses 3 million hours of labor per month to produce corn and 1 million hours per month to produce jeans. Consequently, Felicidad produces 12 million bushels of corn and 16 million pairs of jeans, and Arcadia produces 5 million bushels of corn and 30 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. Felicidad'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 13 million bushels of corn to the other country in exchange for 39 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 17 million bushels per month, and the total production of jeans was 46 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"). Felicidad Arcadia Corn Jeans Corn Jeans (Millions of bushels) (Millions of pairs) (Millions of bushels) (Millions of pairs) Without Trade Production 12 16 5 30 Consumption 12 16 5 30 With Trade Production Trade action Consumption Gains from Trade Increase in Consumption

Answer 1

If a country has comparative advantage in production of a good then the country has lower opportunity cost of producing that good. Nations that produce according to their comparative advantage are maximizing the benefits that they receive from trade and consequently, their national welfare. The benefit that one country accrues from trade is called gains from trade.

From the table above the OC of corn to country F is 4 pairs of jeans and OC of corn in country A is 2 pairs of jeans. Then F has comparitive advantage in corn and A has advantage in jeans.

As both country spacialize, F will produce 16 million bushels of corn and A will produce 40 million pairs of jeans.

Now after trade A will export 39 millions pairs of jeans for 13 million bushels of corn. The result is summarize in the table below

	Felicidad		Arcadia
	CORN	JEANS	CORN	JEANS
Without trade
Production	12	16	5	30
Consumption	12	16	5	30
With Trade
Production	16	0	0	40
Trade action	Export	Import	Import	Export
Consumption	16-13=3	39	13	40-39=1
Gains from trade
Increase in consumption	-9	39-16=23	13-5=8	-29