2. Gains from trade Consider two neighboring island countries called Euphoria an

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2. Gains from trade Consider two neighboring island countries called Euphoria 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 eans Country (Bushels per hour of labor) Pairs per hour of labor) Euphoria Arcadia 20 Initially, suppose Arcadia uses 1 million hours of labor per week to produce rye and 3 million hours per week to produce jeans while Euphoria uses 3 million hours of labor per week to produce rye and 1 million hours per week to produce jeans. Consequently, Euphoria produces 15 million bushels of rye and 20 million pairs of jeans, and Arcadia produces 8 million bushels of rye and 48 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 of jeans, and Arcadia's opportunity cost of producing 1 bushel of rye is has a comparative Euphoria's opportunity cost of producing 1 bushel of rye is of jeans. Therefore, has a comparative advantage in the production of rye, and advantage in the production of jeans. Suppose that each country decides to completely specialize 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 produce produce million bushels per week, and the country that produces jeans will million pairs per week Based on your answers to the prior question, enter each country's production decision in the boxes on the third row (labeled "Production") of the table that follows. Now, suppose the country that produces rye trades 18 million bushels of rye to the other country in exchange for 54 million pairs of jeans. In the following table, use the dropdown menus to select the amount of each good that each country exports and imports on the row labeled "Trade action. Then enter each country's final consumption of each good in the boxes on the row labeled "Consumption. When the two countries did not specialize, the total production of rye was 23 million bushels per week, and the total production of jeans was 68 million pairs per week. Because of specialization, the total production of rye has increased by jeans has increased million bushels per week, and the total production of 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 on the last row (labeled "Increase in consumption")

Explanation / Answer

Euphoria's opportunity cost of producing 1 bushel of rye is (20/5) = 4 million pairs of jeans and Arcardia's opportunity cost of producing 1 bushel of rye is (16/8)=2 million pairs of jeans.Therefore, Arcadia has a comparative advantage in producing rye and Euphoria has a comparative advantage in production of jeans Because they have the lower opportunity cost in their respective production.

Suppose that each country decides to completely specialize 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 produce (8)(4)=32 million bushels per week and the country that produces jeans will produce (20)(4)=80 million paiirs of jeans.

Now,suppose that produces rye trades 18 million bushels of rye to the other country in exchange for 54 million pairs of jeans.

When the two countries did not specialize ,the total production of rye was 23 million bushels per week, and the total production of jeans was 68 miilion pairs per week .Because of specialisation,the total production of rye has increased by (32-23)=9million bushels per week and the total production of jeans has increased by (80-68)= 12 million pairs per week.

Because the two countries produce more and more jeans under specialization ,each country is able to gain from trade.

Therefore, by trade both countries gains from trade.

EUPHORIA ARCADIA Rye (Million of bushels) Jeans (Millions of pairs) Rye (Million of bushels) Jeans (Millions of pairs) Without Trade Production 15 20 8 48 Without Trade Consumption 15 20 8 48 With Trade Production 0 80 32 0 Trade action Gets 18 Gives 54 Gives 18 Gets 54 Consumption 18 (80-54)=26 (32-18)=14 54 Gains from trade Increase in Consmption (18-15)=3 (26-20)=6 (14-8)=6 (54-48)=6

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