3. Gains from trade Consider two neighboring island countries called Felicidad a

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3. Gains from trade

Consider two neighboring island countries called Felicidad and Bellissima. 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.

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Initially, suppose Bellissima uses 1 million hours of labor per week to produce jeans and 3 million hours per week to produce corn, while Felicidad uses 3 million hours of labor per week to produce jeans and 1 million hours per week to produce corn. Consequently, Felicidad produces 15 million pairs of jeans and 20 million bushels of corn, and Bellissima produces 8 million pairs of jeans and 48 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.

Felicidad's opportunity cost of producing 1 pair of jeans __(1)___ of corn, and Bellissima's opportunity cost of producing 1 pair of jeans is_(2)____ of corn. Therefore,_(3)_____ has a comparative advantage in the production of jeans, and__(4)____ 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 week, and the country that produces corn will producemillion bushels per week.

Country Jeans Corn (Pairs per hour of labor) (Bushels per hour of labor) Felicidad 5 20 Bellissima 8

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Explanation / Answer

Opportunity cost refers to giving up of the alternative option while using the best method available .

Opportunity cost in case of Felicidad for 1 pair of jeans is given by

It can produce either 5 jeans or 20 bushels of corn . So for every 1 pair of jeans it needs to produce, it sacrifices 4 bushels of corn . Hence the opportunity cost of producing 1 pair of jeans is given by 4 bushels of corn.

Bellisima's opportunity cost

It can producxe either 8 pairs of jeans or 16 bushels of corn which implies that the opportunity cost of 1 pair of jeans is 2 bushels of corn in case of Bellisima.

Also the country having less opportunity cost in production of a good ie is giving up less of the other good for producing one good is used to produce that good. In this case Bellisima, less of bushels is being given up for producing Pair of jeans , so Bellisima has a comparative advantage in production of jeans .

Also Felicidad has less opportunity cost for production of corn ie for every 1 bushel of corn it gives up about 1/4 production of jeans which is less that (8/16) or 1/2 pair of jeans being given up by Bellisima .

So Felicidad has a comparative advanatge ( ie less of opportunity cost ) in production of corn .

Suppose each country specialises in good for which it has comparative advantage , then Bellisima which specialises in jeans production produces 32 million pairs per week and Felicidad which has the comaprative advantage in production of corns produce 80 million bushels per week

In case of Bellisima , it takes 3 million hours per week to produce corn or 48 bushels of corn is produced.

In bellisima the opportunity cost ( ie not producing corn )for prodcution of jeans is given by 1/2 ie for every one pair of jeans 2 bushels of corn given up . hence 1/2 is the opportunity cost

So totl production of jeans is given by 1/2*48+8= 24+8= 32 million of jeans per week .

similarly the case of Felicidad

The opportunity cost of producing 1 bushel of corn is 1/4. So instead of producing 15 pair of jeans , 15*4 bushels of corn can be produed with the same resources

Hence it will produce 15*4+20 = 80 million bushels of corn per week.

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