Question

# 2. Gains from trade Consider two neighboring island countries called Euphoria and Arcadia. They each have...

Consider two neighboring island countries called Euphoria and Arcadia. They each have 4 million labor hours available per month that they can use to produce corn, jeans, or a combination of both. The following table shows the amount of corn or jeans that can be produced using 1 hour of labor.

Country

Corn

Jeans

(Bushels per hour of labor)

(Pairs per hour of labor)

Euphoria 4 16

Initially, suppose Arcadia uses 1 million hours of labor per month to produce corn and 3 million hours per month to produce jeans while Euphoria uses 3 million hours of labor per month to produce corn and 1 million hours per month to produce jeans. Consequently, Euphoria produces 12 million bushels of corn and 16 million pairs of jeans, and Arcadia produces 6 million bushels of corn and 36 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 corn and jeans it produces.

Euphoria’s opportunity cost of producing 1 bushel of corn is _____ of jeans, and Arcadia’s opportunity cost of producing 1 bushel of corn is ______ of jeans. Therefore, ____has a comparative advantage in the production of corn, and ______has a comparative advantage in the production of jeans.

Suppose that each country decides to completely specialize in the production of the good in which it has a comparative advantage, producing only that good. In this case, the country that produces corn will produce ______ million bushels per month, and the country that produces jeans will produce ______ million pairs per month.

Based on your answers to the prior question, enter each country’s production decision in the boxes on the third row (labeled "Production") of the table that follows.

Now, suppose the country that produces corn trades 14 million bushels of corn to the other country in exchange for 42 million pairs of jeans.

In the following table, use the dropdown menus to select the amount of each good that each country exports and imports on the row labeled "Trade action." Then enter each country’s final consumption of each good in the boxes on the row labeled "Consumption."

When the two countries did not specialize, the total production of corn was 18 million bushels per month, and the total production of jeans was 52 million pairs per month. Because of specialization, the total production of corn has increased by _____ million bushels per month, and the total production of jeans has increased by______ million pairs per month.

Because the two countries produce more corn and more jeans under specialization, each country is able to gain from trade.

Calculate the gains from trade—that is, the amount by which each country has increased its consumption of each good relative to the first row of the table. In the following table, enter this difference in the boxes on the last row (labeled "Increase in consumption").

Corn Jeans Corn Jeans
Production
Consumption
Production
Consumption
Increase in Consumption

Euphoria’s opportunity cost of producing 1 bushel of corn is 16/4 = 4 pair of jeans, and Arcadia’s opportunity cost of producing 1 bushel of corn is 12/6 =2 pair of jeans. Therefore, Arcadia has a comparative advantage in the production of corn, and Euphoria has a comparative advantage in the production of jeans.

Suppose that each country decides to completely specialize in the production of the good in which it has a comparative advantage, producing only that good. In this case, the country that produces corn will produce 6*4 = 24 million bushels per month, and the country that produces jeans will produce 16*4 =64 million pairs per month.

When the two countries did not specialize, the total production of corn was 18 million bushels per month, and the total production of jeans was 52 million pairs per month. Because of specialization, the total production of corn has increased by 24-18 =6 million bushels per month, and the total production of jeans has increased by 64-52=12 million pairs per month.

Now, suppose the country that produces corn trades 14 million bushels of corn to the other country in exchange for 42 million pairs of jeans

.

Corn Jeans Corn Jeans
Production 12 16 6 36
Consumption 12 16 6 36
Production 0 64 24 0
Trade Action (Import/Export) Import 14 Export 42 Export 14 Import 42
Consumption 14 22 10 42
Increase in Consumption 14-12 =2 22-16 = 6 10-6 =4 42-36 = 6

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