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3. Gains from trade

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Consider two neighboring island countries called Bellissima and Euphoria. They each have 4 million labor hours available per week 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)

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

1/2 pair

1/4 pair

2 pairs

4 pairs

1/2 pair

1/4 pair

2 pairs

4 pairs

Bellissima

Euphoria

Bellissima

Euphoria

Points:

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Explanation:

Points:

In the following table, enter each country's production decision on the third row of the table (marked "Production").

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Explanation:

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, 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."

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Explanation:

Points:

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 across the last row (marked "Increase in Consumption").

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Explanation:

Bellissima

Euphoria

Corn

Jeans

Corn

Jeans

(Millions of bushels)

(Millions of pairs)

(Millions of bushels)

(Millions of pairs)

Exports 14

Imports 14

Exports 42

Imports 42

Exports 14

Imports 14

Exports 42

Imports 42

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3. Gains from trade

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Consider two neighboring island countries called Bellissima and Euphoria. They each have 4 million labor hours available per week 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)

Bellissima 6 12 Euphoria 4 16

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

Bellissima's opportunity cost of producing 1 bushel of corn is selector 1 {C}

1/2 pair

1/4 pair

2 pairs

4 pairs

of jeans, and Euphoria's opportunity cost of producing 1 bushel of corn is selector 2   

1/2 pair

1/4 pair

2 pairs

4 pairs

of jeans. Therefore, selector 3   

Bellissima

Euphoria

has a comparative advantage in the production of corn, and selector 4   

Bellissima

Euphoria

has a comparative advantage in the production of jeans.

Points:

Close Explanation

Explanation:

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

Points:

In the following table, enter each country's production decision on the third row of the table (marked "Production").

Close Explanation

Explanation:

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, 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."

Close Explanation

Explanation:

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

Points:

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 across the last row (marked "Increase in Consumption").

Close Explanation

Explanation:

Bellissima

Euphoria

Corn

Jeans

Corn

Jeans

(Millions of bushels)

(Millions of pairs)

(Millions of bushels)

(Millions of pairs)

Without Trade Production 6 36 12 16 Consumption 6 36 12 16 With Trade Production Trade action selector 1   

Exports 14

Imports 14

selector 2   

Exports 42

Imports 42

selector 3   

Exports 14

Imports 14

selector 4   

Exports 42

Imports 42

Consumption Gains from Trade Increase in Consumption

Points:

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Explanation / Answer

Following is the output table when both countries use 4 million hours per good.

Corn (Million)

Jeans (Million)

Bellissima

6 x 4 = 24

12 x 4 = 48

Euphoria

4 x 4 = 16

16 x 4 = 64

(1) Opportunity cost (OC)

In Bellisima, OC of Corn = 48/24 = 2 Jeans

In Euphoria, OC of Corn = 64/16 = 4 Jeans

(2) So,

Bellissima has comparative advantage in Corn (because it can produce Corn at a lower OC: 2 < 4).

Euphoria has comparative advantage in Jeans.

(3)

Country making Corn (Bellissima) will produce 24 million Corn and Country making Jeans (Euphoria) will produce 64 million Jeans.

(4) Bellissima trades (exports) 14 million Corn in exchange of (imports) 42 million Jeans, and Euphoria trades (exports) 42 million Jeans in exchange of (imports) 14 million Corn.

Bellissima

Euphoria

Corn

Jeans

Corn

Jeans

WITHOUT TRADE:

Prod. & Consumption

6

36

12

16

WITH TRADE

Production

24

0

0

64

Trade Action:

Export:

Import:

Import:

Export:

14 Corn

42 Jeans

14 Corn

42 Jeans

Consumption

10

42

14

22

GAIN FROM TRADE

Increase in Consumption

4

6

2

6

Corn (Million)

Jeans (Million)

Bellissima

6 x 4 = 24

12 x 4 = 48

Euphoria

4 x 4 = 16

16 x 4 = 64

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