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

Question

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 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 Corn (Bushels per hour of labor) 16 12 Jeans (Pairs per hour of labor) Country Euphoria Arcadia Initially, suppose Arcadia uses 1 million hours of labor per week to produce jeans and 3 million hours per week to produce corn, while Euphoria uses 3 million hours of labor per week to produce jeans and 1 million hours per week to produce corn. Consequently, Euphoria produces 12 million pairs of jeans and 16 million bushels of corn, and Arcadia produces 6 million pairs of jeans and 36 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 Euphoria's opportunity cost of producing 1 pair of jeans is of corn, and Arcadia'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. comparative advantage, producing only that good. In Suppose that each country completely specializes in the production of the good in which it has this case, the country that produces jeans will produce million pairs per week, and the country that produces corn will produce million bushels 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 jeans trades 14 million pairs of jeans to the other country in exchange for 42 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 18 million pairs per week, and the total production of corn was 52 million bushels per week. Because of specialization, the total production of jeans has increased by corn has increased by million pairs per week, and the total production of million bushels per week.

Explanation / Answer

First we draw the output table when each country uses 4 million hours for each good.

Jeans (Million)

Corn (Million)

Euphoria

4 x 4 = 16

16 x 4 = 64

Arcadia

6 x 4 = 24

12 x 4 = 48

(1) Opportunity cost (OC)

In Euphoria, OC of jeans = 64/16 = 4 corn

In Arcadia, OC of jeans = 48/24 = 2 corn

(2) So,

Arcadia has comparative advantage in jeans (because OC of jeans is lower).

Euphoria has comparative advantage in corn.

(3)

Country making jeans (Arcadia) will produce 24 million jeans (= 6 x 4 million).

Country making corn (Euphoria) will produce 64 million corn (= 16 x 4 million).

(4) Because of specialization,

Production of jeans has increased by 6 million (= 24 million - 18 million).

Production of corn has increased by 12 million (= 64 million - 52 million).

(5) Arcadia trades (exports) 14 million jeans in exchange of (imports) 42 million corn.

EUPHORIA

ARCADIA

Jeans

Corn

Jeans

Corn

WITHOUT TRADE:

Prod. & Consumption

12

16

6

36

WITH TRADE

Production

0

64

24

0

Trade Action:

Import:

Export:

Export:

Import:

14 jeans

42 corn

14 jeans

42 corn

Consumption

14

22

10

42

GAIN FROM TRADE

Increase in Consumption

2

6

4

6

Jeans (Million)

Corn (Million)

Euphoria

4 x 4 = 16

16 x 4 = 64

Arcadia

6 x 4 = 24

12 x 4 = 48

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