Gains from trade
Consider two neighboring island countries called Felicidad and Arcadia. They each have 4 million labor hours available per week that they can use to produce jeans, rye, or a combination of both. The following table shows the amount of jeans or rye that can be produced using 1 hour of labor.
Jeans Rye
Country
(Pairs per hour of labor) (Bushels per hour of labor)
Felicidad 5 20
Arcadia 8 16
Initially, suppose Arcadia uses 1 million hours of labor per week to produce jeans and 3 million hours per week to produce rye while Felicidad uses 3 million hours of labor per week to produce jeans and 1 million hours per week to produce rye. Consequently, Felicidad produces 15 million pairs of jeans and 20 million bushels of rye, and Arcadia produces 8 million pairs of jeans and 48 million bushels of rye. 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 rye it produces.
1. Felicidad's opportunity cost of producing 1 pair of jeans is (1/2, 1/4, 2, 4 Buschels) of rye, and Arcadia's opportunity cost of producing 1 pair of jeans is (1/2, 1/4, 2, 4 Buschels) of rye. Therefore, (Arcadia, Felicia) has a comparative advantage in the production of jeans, and has a comparative advantage in the production of rye.
2. 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 week, and the country that produces rye will produce million bushels per week.
Suppose the country that produces jeans trades 18 million pairs of jeans to the other country in exchange for 54 million bushels of rye.
3. When the two countries did not specialize, the total production of jeans was 23 million pairs per week, and the total production of rye was 68 million bushels per week. Because of specialization, the total production of jeans has increased bymillion pairs per week, and the total production of rye has increased bymillion bushels per week.
Because the two countries produce more jeans and more rye under specialization, each country is able to gain from trade.
4. Complete the table: Production, Consumption, Trade Action, Increase in Consumption. For the answer choices of Trade Action: Jeans(Exports 18, Imports 18), Rye (Exports 54, Imports 54) Everything else are numerical values.
Felicia Felica Arcadia Arcadia
Jeans Rye Jeans Rye
(Millions) (Millions) (Millions) (Millions)
Without Trade
Production 15 20 8 48
Consumption 15 20 8 48
With Trade
Production
Trade Action
Consumption
Gains from Trade
Increase in Trade