3. Suppose there are two states that do not trade: Iowa and Nebraska. Each state

Question

3. Suppose there are two states that do not trade: Iowa and Nebraska. Each state produces the same two goods: corn and wheat. For Iowa the opportunity cost of producing 1 bushel of wheat is 3 bushels of corn. For Nebraska the opportunity cost of producing 1 bushel of corn is 3 bushels of wheat. At present, Iowa produces 20 million bushels of wheat and 120 million bushels of corn, while Nebraska produce 20 million bushels of corn and 120 million bushels of wheat.
a. Explain how, with trade, Nebraska can end up with 40 million bushels of wheat and 120 million bushels of corn while Iowa can end up with 40 million bushels of corn and 120 million bushels of wheat.

Explanation / Answer

Iowa produces corn more effectively than wheat and Nebraska produces wheat more effectively than corn. Economics says that they should do what they are better at doing. So Iowa should produce 300 million corn instead of 100 million of wheat. Nebraska too should now produce 300 million of wheat instead of 100 million of corn.

Net effect is that both have produced a total of 900 million of wheat and corn each. more than their total output of 700 million of wheat and corn each. They can devide the surplus amongst themselves.

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