Alpha and Beta, two tiny islands off the east coast of Tricoli, produce pearls a

Question

Alpha and Beta, two tiny islands off the east coast of Tricoli, produce pearls and pineapples. The production possibilities schedules in the table below describe their potential output in tons per year. Suppose the two islands agree to trade 10 pearls for 10 pineapples. (a) If Alpha produced 6 pearls and 15 pineapples and Beta produced 30 pearls and 8 pineapples before they decided to trade, how much would each be producing after trade became possible? Assume that the two countries specialize just enough to maintain their consumption of the item they export, and make sure each island trades the item for which it has a comparative advantage. Alpha would produce pineapples and pearls. Beta would produce pineapples and pearls. (b) i) How much would the combined production of pineapples increase for the two islands due to trade? Combined production of pineapples increases by . ii) How much would the combined production of pearls increase? Combined production of pearls increases by .

Explanation / Answer

a) A country has comparative advantage in producing a good if opportunity cost of producing that good is lower in that country as compared to other country.

Alpha:

6 pearls = 15 pineapples

1 pearls = 15/6 pineapples

1 pearls = 2.5 pineapples

Opportunity cost of producing 1 pearls is 2.5 units of pineapples. It means that to produce 1 unit of pearl Alpha has to sacrifice 2.5 units of pineapples.

On the other hand, 15 pineapples = 6 pearls

1 pineapple = 6/15 pearls

1 pineapple = 0.4 pearls

Opportunity cost of producing 1 pineapple is 0.4 units of pearls. It means that to produce 1 unit of pineapple Alpha has to sacrifice 0.4 units of pearls.

Beta :

30 pearls = 8 pineapples

1 pearls = 8/30 pineapples

1 pearls = 0.27 pineapples

Opportunity cost of producing 1 pearls is 0.27 units of pineapples. It means that to produce 1 unit of pearl Alpha has to sacrifice 0.27 units of pineapples.

On the other hand, 8 pineapples = 30 pearls

1 pineapple = 30/8 pearls

1 pineapple = 3.75 pearls

Opportunity cost of producing 1 pineapple is 3.75 units of pearls. It means that to produce 1 unit of pineapple Alpha has to sacrifice 3.75 units of pearls.

Since, opportunity cost of producing 1 unit of pineapple is less in Alpha, so island Alpha has comparative advantage in the production of pineapples. On the other hand, Beta has comparative advantage in the production of pearls.

Therefore, Alpha will export pineapples while Beta will export pearls in trade.

b) If Alpha produces only pineapple then it will be able to produce : 15 + 2.5X6 = 15+15 = 30 units of pineapple

If Beta produces only pearls then it will be able to produce : 30 + 3.75X8 = 30 + 30 = 60 units of pearls

Combined production of pineapples increases from 23 to 30 units. It increases by 7 units.

Combined production of pearls increases from 36 to 60 units. It increases by 24 units.

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