Question

Consider two neighboring island countries called Contente and Dolorium. They each have 4 million labor hours available per month 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) Contente 6 12 Dolorium 4 16 Initially, suppose Contente uses 1 million hours of labor per month to produce rye and 3 million hours per month to produce jeans, while Dolorium uses 3 million hours of labor per month to produce rye and 1 million hours per month to produce jeans. Consequently, Contente produces 6 million bushels of rye and 36 million pairs of jeans, and Dolorium produces 12 million bushels of rye and 16 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. Contente's opportunity cost of producing 1 bushel of rye is of jeans, and Dolorium's opportunity cost of producing 1 bushel of rye is of jeans. Therefore, has a comparative advantage in the production of rye, 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 rye will producemillion bushels per month, and the country that produces jeans will producemillion 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 rye trades 14 million bushels of rye to the other country in exchange for 42 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 18 million bushels per month, and the total production of jeans was 52 million pairs per month. Because of specialization, the total production of rye has increased bymillion bushels per month, and the total production of jeans has increased bymillion pairs per month. 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”). Contente Dolorium Rye Jeans Rye Jeans (Millions of bushels) (Millions of pairs) (Millions of bushels) (Millions of pairs) Without Trade Production 6 36 12 16 Consumption 6 36 12 16 With Trade Production Trade action Consumption Gains from Trade Increase in Consumption

Answer 1

Contente's opportunity cost of producing 1 bushel of rye is 12/6 = 2 pairs of jeans and Dolorium's opportunity cost of producing 1 bushel of rye is 16/4 =4 pairs of jeans. Because Contente has a lower opportunity cost for the production of rye. Therefore,Contente has a comparative advantage in the production of rye and Dolorium 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 i.e Contente will produce (4)(6) = 24 million bushels per month And the country that produces jeans i.e Dolorium will produce 4(16)=64 million pairs per month.

Suppose the country that produces corn trades 14 million bushels of rye to the other country in exchange for 42 million pairs of jeans.

		CONTENTE		DOLORIUM
		Rye (milions of bushels)	Jeans (Millions of pairs)	Rye (Millions of bushels)	Jeans (Millions of pairs)
Without trade	Production	6	36	12	16
	Consumption	6	36	12	16
With Trade	Production	24	0	0	64
	Trade action	Export 14	Import 42	Import 14	Export 42
	Consumption	(24-14)=10	42	14	(64-42)=22
Gains from trade	Increase in consumption	(10-6)=4	(42-36)=6	(14-12)=2	(22-16)=6

When the two countries did not specialize ,the total production of rye was 18 million bushels per month and the total production of jeans was 52 millions pairs per month. Because of specialization ,the total production of rye was 24 million bushels per month and total production of jeans was 64 million pair per month. This implies that because of specialization , total production of rye has increased by (24-18)=6 million bushels per month and total production of jeans has increased by (64-52)=12 million pairs per month.