Question

Consider two neighboring island countries called Felicidad and Contente. They each have 4 million labor hours available per week 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)
Felicidad	5	20
Contente	8	16

Initially, suppose Contente uses 1 million hours of labor per week to produce rye and 3 million hours per week to produce jeans, while Felicidad uses 3 million hours of labor per week to produce rye and 1 million hours per week to produce jeans. Consequently, Felicidad 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.

Felicidad'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 produce

million bushels per week, and the country that produces jeans will produce

million pairs per week.

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,” and enter each country's final consumption of each good on the line marked “Consumption.”

When the two countries did not specialize, the total production of rye was 23 million bushels per week, and the total production of jeans was 68 million pairs per week. Because of specialization, the total production of rye has increased by

million bushels per week, and the total production of jeans has increased by

million pairs per week.

Because the two countries produce more rye 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 across the last row (marked “Increase in Consumption”).

Answer 1

Countries Contente and Felicidad both have 4 million hours of labor each.

Without trade, Contente can either produce 8*4 million = 32 million bushels of rye or 16*4 million = 64 million pairs of jeans.

Thus, opportunity cost of producing rye for Contente = pairs of jeans sacrificed / bushels of rye produced = 64 million/32 million = 2

Again, opportunity cost of producing jeans for Contente = bushels of rye sacrificed / pairs of jeans produced = 32 million/64 million = 0.5

Let us suppose, Contente produces and consumes 8 million bushels of rye and 48 million pairs of jeans.

Similarly, without trade, Felicidad can either produce 5*4 million = 20 million bushels of rye or 20*4 million = 80 million pairs of jeans.

Thus, opportunity cost of producing rye for Felicidad = pairs of jeans sacrificed / bushels of rye produced = 80 million/20 million = 4

Again, opportunity cost of producing jeans for Felicidad = bushels of rye sacrificed / pairs of jeans produced = 20 million/80 million = 0.25

Let us suppose, Felicidad produces and consumes 15 million bushels of rye and 20 million pairs of jeans.

Total production without trade is 23 million bushels of rye and 68 million pairs of jeans.

As opportunity cost of producing rye is lower for Contente and opportunity cost of producing jeans is lower for Felicidad, Contente has comparative advantage in the production of rye and Felicidad has comparative advantage in the production of jeans.

Thus, under specialization, Contente will only produce 32 million bushels of rye and Felicidad will only produce 80 million pairs of jeans.

As total production under specialization is greater than without trade, both countries will gain from trade.

For trade, suppose, each country trades 18 million bushels of rye for 54 million pairs of jeans.

Then, if Contente consumes 8 million bushels of rye (out of 32 million bushels of rye) , it can export remaining 24 million bushels of rye to Felicidad for which it gets (54/18)*24 = 72 million pairs of jeans. Thus, Contente gain 72-48=24 million pairs of jeans. Thus, increase in consumption of jeans = 24 million pairs of jeans.

Similarly, if Felicidad consumes 20 million pairs of jeans (out of 80 million pairs of jeans) , it can export remaining 60 million pairs of jeans to Contente for which it gets (18/54)*60 = 20 million bushels of rye. Thus, Felicidad gain 20-15=5 million bushels of rye. Thus, increase in consumption of rye = 5 million bushels of rye.