Question

3. Gains from trade Consider two neighboring island countries called Dolorium and Contente. They each have 4 million labor hours available per month that they can use to produce jeans, rye, or a combination of both. The following table shows the amount of jeans or rye that can be produced using 1 hour of labor. Country Jeans Rye (Pairs per hour of labor) (Bushels per hour of labor) Dolorium 4 16 Contente 6 12 Initially, suppose Contente uses 1 million hours of labor per month to produce jeans and 3 million hours per month to produce rye, while Dolorium uses 3 million hours of labor per month to produce jeans and 1 million hours per month to produce rye. Consequently, Dolorium produces 12 million pairs of jeans and 16 million bushels of rye, and Contente produces 6 million pairs of jeans and 36 million bushels of rye. 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 jeans and rye it produces. Dolorium's opportunity cost of producing 1 pair of jeans is4 bushels of rye, and Contente's opportunity cost of producing 1 pair of jeans is of rye. Therefore, has a comparative advantage in the production of jeans, and has a comparative advantage in the production of rye. 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 jeans will produce million pairs per month, and the country that produces rye will produce million bushels 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 jeans trades 14 million pairs of jeans to the other country in exchange for 42 million bushels of rye. 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 jeans was 18 million pairs per month, and the total production of rye was 52 million bushels per month. Because of specialization, the total production of jeans has increased by million pairs per month, and the total production of rye has increased by million bushels per month. Because the two countries produce more jeans and more rye under specialization, each country is able to gain from trade.

Answer 1

Comparative Advantage

                                                   Dolorium       Contente       

Jeans (millions of pairs)              4                6

Rye (millions of bushels)             16                 12

1. Dolorium’s opportunity cost of producing one pair of jeans is (16/4=4).
2. Contente’ s opportunity cost of producing one pair of jeans is (12/6=2).
3. Dolorium’s opportunity cost of producing one bushel of rye is 4/16=0.25.
4. Contente’s opportunity cost of producing one bushel of rye is 6/12=0.5

Contente has a comparative advantage in producing pair of jeans as the opportunity cost is lower (2 versus 4).

Dolorium has a comparative advantage in producing bushels of Rye as the opportunity cost is lower (0.25 versus 0.75).

If Contente produces jeans, in which it has comparative advantage, it will produce (4 million labor hours x 6) =24 million pairs of jeans.

If Dolorium produces rye, in which it has comparative advantage, it will produce (4 million labor hours x 16) = 64 million bushels of rye.

	Dolorium		Contente
	Jeans	Rye	Jeans	Rye
	Millions of pairs	Milions of bushels	Millions of pairs	Milions of bushels
Without trade
Production	12	16	6	36
Consumption	12	16	6	36
With trade
Production	0	64	24	0
Trade Action		-42	-14	42
Consumption	14	22	10	42
Gains from trade
Increase in consumption	2	6	4	6