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

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3. Gains from trade Consider two neighboring island countries called Contente and Dolorium. 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 eans (Pairs per hour of labor) 16 20 (Bushels per hour of labor) Country Contente Dolorium Initially, suppose Contente uses 1 million hours of labor per month to produce corn and 3 million hours per month to produce jeans, while Dolorium uses 3 million hours of labor per month to produce corn and 1 million hours per month to produce jeans. Consequently, Contente produces 8 million bushels of corn and 48 million pairs of jeans, and Dolorium produces 15 million bushels of corn and 20 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 is 2 pairs of eans, and Dolorium's opportunity cost of producing 1 bushel of corn is 4 pairs of jeans. Therefore, Contente has a comparative advantage in the production of corn, and Doloríum 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 mllion pairs per month.

Explanation / Answer

Answer:

Contente's opportunity cost of producing 1 bushel of corn is 16/8= 2 pairs of jeans. And Dolorium's opportunity cost of producing 1 bushel of corn is 20/5 = 4 pairs of jeans. Because Contente has lower opportunity cost in producing corns. Therefore, Contente has a comparative advantage in producing corns.

Contente's opportunity cost of producing 1 pair of jean is 8/16 = 0.5 bushel of corn. And Dolorium's opportunity cost of producing 1 pair of jean = 5/20 = 0.25 bushel of corn. Because Dolorium has a lower opportunity cost in producing jeans. It implies that Dolorium has a comparative advantage in producing jeans.

Suppose that each country completely specialises in the production of the good in which it has a comparative advantage , producing only that good . In this case, the country i.e Contente that produces corn will produce 8(4)= 32 million bushels and the country i.e Dolorium that produces jeans will produce 20(4) = 80 milllion pairs of jeans.

Suppose the country that produces corn trades 18 million bushels of corn to the other country in exchange for 54 million pairs of jeans.

When the two countries did not specialize , the total production of corn was 23 million bushels per month, and the total production of jeans was 68 million pairs per month . Because of specialisation, the total production of corn is 32 million bushels per month. It implies that total production of corn has increased by (32-23) = 9 million bushels of corn per month.

And the total production of jeans is 80 million pairs of jeans. It implies that total production of jeans has increased by (80-68)= 12 million pairs of jeans per month.

Because the two countries produce morecorn and jeans under specialisation , each country is able to gain from trade.

Contente Dolorium Corn (Millions of bushels) Jeans (Million of pairs) Corn (Millions of bushels) Jeans (Millions of pairs) Without trade Production 8 48 15 20 Consumption 8 48 15 20 With trade Production 32 0 0 80 Trade action Exports 18 Imports 54 Imports 18 Export 54 Consumption (32-18)=14 54 18 (80-54)=26 Gains from trade Increase in consumption (14-8) =6 (54-48)=6 (18-15)=3 (26-20)=6

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