3. Gains from trade Consider two neighboring island countries called Contente an

Question

3. Gains from trade Consider two neighboring island countries called Contente and Euphoria. 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. Corn Country Contente Euphoria Jeans (Pairs per hour of labor) 12 16 (Bushels per hour of labor) 4 Initially, suppose Contente 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, Contente 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. Contente's opportunity cost of producing 1 bushel of corn isof jeans, and Euphoria's opportunity cost of producing 1 bushel of corn is of jeans, and Euphoria's opportunity cost of producing 1 bushel of corm 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 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 month, and the country that produces jeans will produce million pairs per month.

Explanation / Answer

Contente can produce either 6 bushels of corn or 12 pairs of jeans with given resources, So opportunity cost of producing 1 bushel of corn in Contente is 2 pairs of jeans . or in other words the opportunity cost of producing 1 pair of jeans is 1/2 bushels of corn.

If we see the case of Europhia , it can produce either 4 bushels of corn or 16 pair of jeans. So the opportunity cost of producing 1 bushel of corn in europhia is 4 pairs of jeans . or in other words the opportunity cost of producing 1 pair of jeans is 1/4 bushels of corn.

Also we know that the country having the less opportunity cost of a good should produce it ie if it can produce the good at a lesser cost ( opportunity cost ) than any other country .

Here we can see that here Contente has a comparative advantage in producing corn while Europhia has it in producing jeans .

Reason : The opportunity cost of Contente is less in production of corn as compared to Europhia ie it is giving up less pair of jeans as compared to other country .

If we see the opportunity cost of Europhia for jeans it is giving up only 1/4 bushel of corn while Conmtente is giving up 1/2 bushel of corn . So Europhia with lower opportunity cost has a comparative advantage in production of jeans .

We are given the labour hours required to produce both the goods in both countries .

In case of Contente which specialises in production of corn it can produce 6 million bushels of corn . Aslo when not producing jeans the resources from it can be diverted for producing corn.

36 million pair of jeans are produced . Also we know that the opportunity cost of producing 1 bushel of corn is 2 pair of jeans .

so bushles of corn produced instead of pair of jeans is 36/2= 18 million bushels of corn.

Adding them both we get 18 +6= 24 million bushels of corn . ( when specialisation is there )

Next we see for the case of Europhia whihc has the comparative advantage in case of pair of jeans.

With the given amount of 12 million bushels of corn and 1/4 as the opportunity cost we can simply divide them and get 12/(1/4) = 48 million pair of jeans

Also it ws already producing 16 pair of jeans .

so total is 16 + 48 = 64 million pair of jeans ( when specialisation is there )

Due to trade , the the production of both the goods has increased . in case of corn it has increased by 6 (ie 24-18)million bushels of corn and in case of jeans it has increased by 12 ( ie 64 -52)million pair of jeans .

gains from trade:

increase in consumption

Contente Contente Europhia Europhia Corn Jeans Corn Jeans Without trade Production 6 36 12 16 Consumption 6 36 12 16 With trade Production 24 0 0 64 trade gives/exports 14 gets 42 imports/ gets 14 gives 42 consumption 10 42 14 22

gains from trade:

increase in consumption

10-6=4 42-36=6 14-12=2 22-16=6

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