Suppose there are two states that do not trade: Iowa and Nebraska. Each state pr

Question

Suppose there are two states that do not trade: Iowa and Nebraska. Each state produces the same two goods: corn and wheat. For Iowa the opportunity cost of producing 1 bushel of wheat is 3 bushels of corn. For Nebraska the opportunity cost of producing 3 bushel of wheat is 1 bushels of corn. At present, Iowa produces 50 million bushels of wheat and 300 million bushels of corn, while Nebraska produces 50 million bushels of corn and 300 million bushels of wheat. a. Explain how, with trade, Nebraska can end up with 70 million bushels of wheat and 300 million bushels of corn while Iowa can end up with 70 million bushels of corn and 300 million bushels of wheat. To maximize production of both states, Iowa should produce million bushels of corn and million bushels of wheat while Nebraska should produce million bushels of wheat and million bushels of corn. Iowa can trade a maximum of million bushels of corn for the million bushels of wheat that it needs. Nebraska can trade a maximum of million bushels of wheat for the million bushels of corn it needs. b. If the states ended up with the numbers given in a, how much would the trader get? million bushels of wheat. million bushels of corn.

Explanation / Answer

Iowa produces corn more effectively than wheat and Nebraska produces wheat more effectively than corn. Economics says that they should do what they are better at doing. So Iowa should produce 300 million corn instead of 100 million of wheat. Nebraska too should now produce 300 million of wheat instead of 100 million of corn.

Net effect is that both have produced a total of 900 million of wheat and corn each. more than their total output of 700 million of wheat and corn each. They can devide the surplus amongst themselves.

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