Question

3. Gains from trade Consider two neighboring island countries called Felicidad and Arcadia. They each have 4 million labor hours available per week that they can use to produce rye, jeans, or a combination of both. The following table shows the amount of rye or jeans that can be produced using 1 hour of labor. Country Rye Jeans (Bushels per hour of labor) (Pairs per hour of labor) Felicidad 8 32 Arcadia 12 24 Initially, suppose Arcadia uses 1 million hours of labor per week to produce rye and 3 million hours per week to produce jeans, while Felicidad uses 3 million hours of labor per week to produce rye and 1 million hours per week to produce jeans. Consequently, Felicidad produces 24 million bushels of rye and 32 million pairs of jeans, and Arcadia produces 12 million bushels of rye 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 rye and jeans it produces. Felicidad's opportunity cost of producing 1 bushel of rye is4 pairs of jeans, and Arcadia's opportunity cost of producing 1 bushel of rye is2 pairs of jeans. Therefore,Arcadia has a comparative advantage in the production of rye, andFelicidad 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 rye will producemillion bushels per week, and the country that produces jeans will producemillion pairs per week. In the following table, enter each country's production decision on the third row of the table (marked "Production"). Suppose the country that produces rye trades 26 million bushels of rye 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 rye was 36 million bushels per week, and the total production of jeans was 104 million pairs per week. Because of specialization, the total production of rye has increased bymillion bushels per week, and the total production of jeans has increased bymillion pairs per week. Because the two countries produce more rye 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 Rye Jeans Rye 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

Answer 1

Felicidad's opportunity cost of producing one bushel of rye is 4 million pairs of jeans and Arcadia's opportunity cost of producing one bushel of rue is equal to 2 million pairs of jeans. Therefore, Felicidad has a comparative advantage in the production of jeans and Arcadia has a comparative advantage in the production of rye.

In case of complete specialization, Felicidad wil produce 128 million pairs of jeans and Arcadia will produce 48 million bushels of rye.

Because of specializtion, the production of rye has increased by 12 million bushels and the production of jeans has increased by 24 million pairs per week.

Gains from trade:

Felicidad : Production of jeans: 128 million, production of rye: 0

Consumption of jeans: 50 million, consumption of rye: 26 million

Gains from trade: 2 million rye and 38 million pairs of jeans

Arcadia:

productio of rye: 48 million, productio of jeans: 0

consumption of rye: 22 million, consumption of jeans: 78 million

Gains from trade: 10 million rye and 6 miliom pairs of jeans