15. Gains from trade Consider two neighboring island countries called Bellissima
ID: 1142944 • Letter: 1
Question
15. Gains from trade Consider two neighboring island countries called Bellissima and Dolorium. 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. Rye (Bushels per hour of labor) Country Bellissima Dolorium Jeans (Pairs per hour of labor) 16 20 Initially, suppose Bellissima 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, Bellissima produces 8 million bushels of rye and 48 million pairs of jeans, and Delorium produces 15 million bushels of rye and 20 millin 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 Bellissima's opportunity cost of producing 1 bushel of rye isof jeans, and Dolorium's opportunity cost of producing 1 bushel of rye is 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 of jeans. Therefore, has a comparative advantage in the production of rye, and has a comparative this case, the country that produces rye will produceillion bushals per month, and the country that produces jeans will roduce million pairs per month. 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. 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 andExplanation / Answer
E 508
Following is the output table when both countries use 4 million hours per good.
Rye (Million)
Jeans (Million)
Bellissima
8 x 4 = 32
16 x 4 = 64
Dolorium
5 x 4 = 20
20 x 4 = 80
(1) Opportunity cost (OC)
In Bellisima, OC of Rye = 64/32 = 2 Jeans
In Dolorium, OC of Rye = 80/20 = 4 Jeans
(2) So,
Bellissima has comparative advantage in Rye (because it can produce Rye at a lower OC: 2 < 4).
Dolorium has comparative advantage in Jeans.
(3)
Country making Rye (Bellissima) will produce 32 million Rye and Country making Jeans (Dolorium) will produce 80 million Jeans.
(4)
Total production of rye increased by 9 million (= 32 million – 23 million) and total production of jeans increased by 12 million (= 80 million – 68 million).
(4) Bellissima trades (exports) 18 million Rye in exchange of (imports) 54 million Jeans, and Dolorium trades (exports) 54 million Jeans in exchange of (imports) 18 million Rye.
Bellissima
Dolorium
Rye
Jeans
Rye
Jeans
WITHOUT TRADE:
Prod. & Consumption
8
48
15
20
WITH TRADE
Production
32
0
0
80
Trade Action:
Export:
Import:
Import:
Export:
18 Rye
54 Jeans
18 Rye
54 Jeans
Consumption
14
54
18
26
GAIN FROM TRADE
Increase in Consumption
6
6
3
6
Rye (Million)
Jeans (Million)
Bellissima
8 x 4 = 32
16 x 4 = 64
Dolorium
5 x 4 = 20
20 x 4 = 80
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