3. Gains from trade Consider two neighboring island countries called Bellissima

Question

3. Gains from trade Consider two neighboring island countries called Bellissima and Dolorium. They each have 4 million labor hours available per month that they can use to produce jeans, corn, or a combination of both. The following table shows the amount of jeans or corn that can be produced using 1 hour of labor. Corn (Bushels per hour of labor) 12 16 Jeans Country(Pairs per hour of labor) Bellissima Dolorium 4 Initially, suppose Bellissima uses 1 million hours of labor per month to produce jeans and 3 million hours per month to produce corn, while Dolorium uses 3 million hours of labor per month to produce jeans and 1 million hours per month to produce corn. Consequently, Bellissima produces 6 million pairs of jeans and 36 million bushels of corn, and Dolorium produces 12 million pairs of jeans and 16 million bushels of corn. 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 jeans and corn it produces. Bellissima's opportunity cost of producing 1 pair of jeans is of corn, and Dolorium's opportunity cost of producing 1 pair of jeans is of corn. Therefore, has a comparative advantage in the production of jeans, and has a comparative advantage in the production of corn 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 jeans will produce million pairs per month, and the country that produces corn will produce million bushels per month.

Explanation / Answer

Bellissima's opportunity cost of producing 1 pair of jeans is 12/6= 2 bushel of corn and Dolorium's opportunity cost of producing 1 pair of jeans is 16/4 = 4 bushel of corn. Therefore, Bellissima has a comparative advantage in the production of jeans because it has a lower opportunity cost for the production of jeans.

Similarly, Bellissima''s opportunity cost of producing 1 bushel of corn is 6/12= 0.5 pair of jeans And Dolorium's opportunity cost of producing 1 bushel of corn is 4/16= 0.25 pair of jeans. Therefore, Dolorium has a comparative advantage in the production of corn because it has a lower opportunity cost for the production of corn.

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 (i.e Bellissima ) that produces jeans will produce (4 million)(6)=24 million pairs per month. And the country (i.e Dolorium) that produces corn will produce (4 million)(16)=64 million bushels per month.

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

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

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

BELLISSIMA DOLORIUM Jeans (Millions of pairs) Corn (Millions of bushels) Jeans (Millions of pairs) orn (Millions of bushels) Without trade Production 6 36 12 16 Consumption 6 36 12 16 With trade Production 24 0 0 64 Trade action Export 14 Import 42 Import 14 Export 42 Consumption (24-14)=10 42 14 (64-42)=22 Gains from trade Increase in consumption (10-6)=4 (42-36)=6 (14-12)=2 (22-16)=6

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