Question

3. Gains from trade

Consider two neighboring island countries called Arcadia and Euphoria. They each have 4 million labor hours available per month that they can use to produce jeans, corn, or a combination of both. The following table shows the amount of jeans or corn that can be produced using 1 hour of labor.

Country	Jeans	Corn
	(Pairs per hour of labor)	(Bushels per hour of labor)
Arcadia	12	24
Euphoria	8	32

Initially, suppose Arcadia uses 1 million hours of labor per month to produce jeans and 3 million hours per month to produce corn, while Euphoria uses 3 million hours of labor per month to produce jeans and 1 million hours per month to produce corn. Consequently, Arcadia produces 12 million pairs of jeans and 72 million bushels of corn, and Euphoria produces 24 million pairs of jeans and 32 million bushels of corn. 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 corn it produces.

Arcadia's opportunity cost of producing 1 pair of jeans is   of corn, and Euphoria's opportunity cost of producing 1 pair of jeans is   of corn. Therefore,   has a comparative advantage in the production of jeans, and   has a comparative advantage in the production of corn.

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 corn 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 26 million pairs of jeans to the other country in exchange for 78 million bushels of corn.

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 36 million pairs per month, and the total production of corn was 104 million bushels per month. Because of specialization, the total production of jeans has increased by

million pairs per month, and the total production of corn has increased by

million bushels per month.

Because the two countries produce more jeans and more corn 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").

	Arcadia		Euphoria
	Jeans	Corn	Jeans	Corn
	(Millions of pairs)	(Millions of bushels)	(Millions of pairs)	(Millions of bushels)
Without Trade
Production	12	72	24	32
Consumption	12	72	24	32
With Trade
Production
Trade action
Consumption
Gains from Trade
Increase in Consumption

Answer 1

Each have 4 million labor hours

Country	Jeans	Corn
	(Pairs per hour of labor)	(Bushels per hour of labor)
Arcadia	12	24
Euphoria	8	32

Arcadia's opportunity cost of producing 1 pair of jeans is 24/12 = 2 bushel of corn, and Euphoria's opportunity cost of producing 1 pair of jeans is 32/8 = 4 bushel of corn. Therefore, Arcadia has a comparative advantage in the production of jeans, and Euphoria has a comparative advantage in the production of corn.

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 12*4 = 48 million pairs per month, and the country that produces corn will produce 32*4 = 128 million bushels per month.

When the two countries did not specialize, the total production of jeans was 36 million pairs per month, and the total production of corn was 104 million bushels per month. Because of specialization, the total production of jeans has increased by 48-36 = 12 million pairs per month, and the total production of corn has increased by 128-104 = 24 million bushels per month.

Suppose the country that produces jeans trades 26 million pairs of jeans to the other country in exchange for 78 million bushels of corn.

	Arcadia		Euphoria
	Jeans	Corn	Jeans	Corn
	(Millions of pairs)	(Millions of bushels)	(Millions of pairs)	(Millions of bushels)
Without Trade
Production	12	72	24	32
Consumption	12	72	24	32
With Trade
Production	48	0	0	128
Trade action	Exports 26	Imports 78	Imports 26	Exports 78
Consumption	22	78	26	50
Gains from Trade
Increase in Consumption	10	6	2	18