3. Gains from trade Consider two neighboring island countries called Dolorium an
ID: 1135729 • Letter: 3
Question
3. Gains from trade Consider two neighboring island countries called Dolorium and Contente. They each have 4 million labor hours available per month 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 Rye Jeans (Bushels per hour of labor) (Pairs per hour of labor) Dolorium 5 20 Contente 8 16 Initially, suppose Contente uses 1 million hours of labor per month to produce rye and 3 million hours per month to produce jeans, while Dolorium uses 3 million hours of labor per month to produce rye and 1 million hours per month to produce jeans. Consequently, Dolorium produces 15 million bushels of rye and 20 million pairs of jeans, and Contente 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. Dolorium's opportunity cost of producing 1 bushel of rye is of jeans, and Contente's opportunity cost of producing 1 bushel of rye is of jeans. Therefore, has a comparative advantage in the production of rye, and 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 month, and the country that produces jeans will producemillion pairs per month. In the following table, enter each country's production decision on the third row of the table (marked
Explanation / Answer
Dolorium:
5 bushels of Rye = 20 pairs of Jeans
1 bushel of Rye = 20/5 = 4 pairs of Jeans
Opportunity cost of producing 1 bushel of Rye is 4 pairs of Jeans.
Contente:
8 bushels of Rye = 16 pairs of Jeans
1 bushel of Rye = 2 pairs of Jeans
Opportunity cost of producing 1 bushel of Rye is 2 pairs of Jeans.
A country has a comparative advantage in producing that good if the opportunity cost of producing that good is lower in that country as compared to another country.
Opportunity cost of producing 1 bushel of Rye is lower in Contente so, Contente has a comparative advantage in Rye and Dolorium has a comparative advantage in Jeans.
When Contente uses 4 million hours of labor to produce Rye then it is able to produce 4 million X 8 = 32 million bushels of Rye
When Dolorium uses 4 million hours of labor to produce Jeans then it is able to produce 4 million X 20 = 80 million pairs of Jeans
Total production of Rye increased by 32 million - 23 million(15 + 8) = 9 million
Total production of Jeans increased by 80 million - 68 million(20 + 48) = 12 million
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