3. Gains from trade Consider two neighboring island countries called Arcadia and

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 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 Rye Jeans Country(Bushels per hour of labor) Arcadia Euphoria (Pairs per hour of labor) 12 16 tnitially, suppose Arcadia uses 1 million hours of labor per month to produce rye and 3 million hours per month to produce jeans, while Euphoria uses million hours of labor per month to produce rye and 1 million hours per month to produce jeans. Consequently, Arcadia produces 6 million busheis of ye and 36 million pairs of jeans, and Euphoria produces 12 million busheis 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. of jeans, and Euphoria's opportunity cost of producing 1 bushel o, rye is has a comparative Arcadia'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 completely specializes in the production of the good in which it has comparative advantage, producing only that good. In

Explanation / Answer

Arcadia's opportunity cost of producing 1 bushel of rye is 2 pairs of jeans (=12/6), and Euphoria's opportunity cost of producing 1 bushel of rye is 4 pairs of jeans (=16/4). Therefore, Arcadia has a comparative advantage in the production of rye, and Euphoria 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 produce 24 million bushels per month (= 6 x 4), and the country that produces jeans will produce 64 million pairs per month. (= 16 x 4)

Because of specialization, the total production of rye has incraesed by 6 million bushels per month, and the total production of jeans has increased by 12 million pairs per month.

Increase in consumption = consumption after trade - consumption before trade

Arcadia Euphoria 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 24 0 0 64 Trade action -14 42 14 -42 Consumption 10 42 14 22 Gains from Trade Increase in Consumption 4 6 2 6

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