Homework (Ch 03) Consider two neighboring island countries called Contente and D

Question

Homework (Ch 03) Consider two neighboring island countries called Contente and Dolorium. 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 Country Contente Doloriunm Rye (Bushels per hour of labor) Jeans (Pairs per hour of labor) 16 Initially, suppose Contente uses 1 million hours of labor per week to produce rye and 3 million hours per week to produce jeans, while Dolorium uses 3 million hours of labor per week to produce rye and 1 million hours per week to produce jeans. Consequently, Contente produces 8 ilion bushels of rye and 48 million pairs of jeans, and Dolorium produces 15 million bushels of rye and 20 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 contentes opportunity cost of producing i bushel o rye is 1/2 pair of eans, and Dolonum's opportunity cost of producing 1 bushel of rye is 1/4 pair of jeans. Therefore, Contente has a comparative advantage in the production of rye, and Dolorium 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 producemillion bushels per week, and the country that produces jeans will produce million pairs 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 rye trades 18 million bushels of rye to the other country in exchange for 54 million pairs of jeans.

Explanation / Answer

Solution:

Using the given information then, we can say that given one labor hour, country Contente can either produce 8 bushels of rye or 16 pairs of jeans. So, 1 bushel of rye will require to sacrifice 16/8 = 2 pairs of Jeans. So, opportunity cost of producing 1 bushel or rye is 2 pairs of jeans.

Similarly, given one labor hour, country Dolorium can either produce 5 bushels of rye or 20 pairs of jeans. So, 1 bushel of rye, for this country, will require sacrifice of 20/5 = 4 pairs of Jeans. So, opportunity cost of producing 1 bushel of rye is 4 pairs of jeans.

Clearly, since opportunity cost of producing rye is lower for Contente as compared to Dolorium (2 pairs of jeans < 4 pairs of jeans), Contente has comparative advantage in production of rye. Similarly, Dolorium has a comparative advantage in production of jeans as opportunity cost of jeans production is lower for Dolorium than for Contente (1/4 bushels of rye < 1/2 bushels of rye).

Now, that each country specializes in production of one good, Contente specializes in production of rye (as it has comparative advantage in this), it will denote it's entire labor hours in production of rye. Now if 1 labor hour helps produce 8 bushels of rye, total of 4 million labor hours in a week will result in production of 8*4 million bushels = 32 million bushels of rye. Similarly, Dolorium specializes in production of jeans, and so it will denote all of its labor hours in production of jeans. Dolorium can produce 20 pairs of jeans in a labor hours, thus with availability of 4 million labor hours, total of 20*4 million pairs = 80 million pairs of jeans will be produced in a week.

We have already seen, and also have been given that without trade, total production of rye = 23 million bushels of rye and total production of jeans = 68 million pairs of jeans. While with specialization, total production of rye = 32 millions bushels (32 million bushels produced in Contente and 0 produced in Dolorium) and total production of jeans = 80 million pair of jeans (none produced by Contente and 80 million pairs produced by Dolorium)

Now, accordingly we can fill up the table as follows:

Increase in consumption (Consumption after trade - consumption before trade)

So, clearly the consumption for all in both countries in both goods has increased after trade, reassuring that both countries have gained from the trade.

CONTENTE CONTENTE DOLORIUM DOLORIUM Rye Jeans Rye Jeans Without trade: Production 8 48 15 20 Consumption 8 48 15 20 With trade Production 32 0 0 80 Trade Action Export Import Import Export Consumption (production - amount exported + amount imported) 32 - 18 = 14 0 + 54 = 54 0 + 18 = 18 80 - 54 = 26 Gains from trade:

Increase in consumption (Consumption after trade - consumption before trade)

14 - 8 = 6 54 - 48 = 6 18 - 15 = 3 26 - 20 = 6

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