- Gains from Trade You find yourself in a lonely oasis in the desert. The only t
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Question
- Gains from Trade
You find yourself in a lonely oasis in the desert. The only two things you can produce are either dates or water. In a day you can either gather 100 dates or collect 50 liters of water. And you choose to spend 4 days a week gathering dates and 3 days a week collecting water.
a.) What are your opportunity costs of water and dates?
Now imagine in the neighbor oasis is Mohammed and he can produce in a day either 150 dates or 60 liters of water. And he chooses to spend 4 days a week gathering dates and 3 days a week collecting water.
b.) What are Mohammed’s opportunity costs of water and dates?
c.) Who has an absolute advantage in dates and water production and who has a
comparative advantage in dates and water production?
d.) How many dates and liters of water are you and Mohammed producing per week
before trade?
e.) How many dates and liters of water are you and Mohammed producing after you
decided to trade with each other? (Hint: Each one Specializes)
f.) Think of an exchange that would make both parties better off than before they
decided to trade with each other.
Explanation / Answer
a) Opportunity cost of water = Number of dates that can be collected by using the the same time with which one litre of water can be gathered. = 100 dates/50 litre = 100/50 = 2 dates.
Opportunity cost of dates = Number of litres of water that can be collected by using the the same time with which one date can be gathered. = 50/100 = 0.5 litre of water.
b) Mohammed's Opportunity cost of water = 150/60 = 2.5 dates
Mohammed's Opportunity cost of dates = 60/150 = 0.4 litre of water.
c) Mohammed has absolute advatnage in gathering both water and dates. Because he can gather more litres of wter and dates by consuming same time.
Where as I have comparative advantage in producing water because it has less opportunity cost than Mohammed and Mohammed has comparative advatnge of producing dates.
d) Before trade :
Total dates = 4*100 + 4*150 = 1000 dates
Total litlres of water = 3*50 + 3*60 = 330 litres of water.
e) if trade takes place I will produce water only and Mohammed will produce dates only.
Total litres of water = 7*50 = 350 litres of water
and Total dates = 7*150 = 1050 dates.
f) If they exchange 100 dates = 45 litres of water both parties will be better off. As now because of trade I will have 100 dates + 5 litres of water even if we exchange full what we produce and Mohammed will have 45 litres + 50 dates(or 22.5 dats more) per day.
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