3. Gains from trade Consider two neighboring island countries called Contente and Euphoria. They each have 4 million labor hours available per week that they can use to produce rye, jeans, or a combination of both. The following table shows the amount of rye or jeans that can be produced using 1 hour of labor.
Country
Rye
Jeans
(Bushels per hour of labor)
(Pairs per hour of labor)
Contente 8 16
Euphoria 5 20
Initially, suppose Contente uses 1 million hours of labor per week to produce rye and 3 million hours per week to produce jeans, while Euphoria uses 3 million hours of labor per week to produce rye and 1 million hours per week to produce jeans. Consequently, Contente produces 8 million bushels of rye and 48 million pairs of jeans, and Euphoria produces 15 million bushels of rye 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 rye and jeans it produces.
Contente's opportunity cost of producing 1 bushel of rye is of jeans, and Euphoria's opportunity cost of producing 1 bushel of rye is of jeans. Therefore, has a comparative advantage in the production of rye, and 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 rye will produce
million bushels per week, and the country that produces jeans will produce
million pairs per week.
In the following table, enter each country's production decision on the third row of the table (marked “Production”).
Suppose the country that produces rye trades 18 million bushels of rye to the other country in exchange for 54 million pairs of jeans.
In the following table, select the amount of each good that each country exports and imports in the boxes across the row marked “Trade Action,” and enter each country's final consumption of each good on the line marked “Consumption.”
When the two countries did not specialize, the total production of rye was 23 million bushels per week, and the total production of jeans was 68 million pairs per week. Because of specialization, the total production of rye has increased by
million bushels per week, and the total production of jeans has increased by
million pairs per week.
Because the two countries produce more rye and more jeans under specialization, each country is able to gain from trade.
Calculate the gains from trade—that is, the amount by which each country has increased its consumption of each good relative to the first row of the table. In the following table, enter this difference in the boxes across the last row (marked “Increase in Consumption”).
Contente
Euphoria
Rye
Jeans
Rye
Jeans
(Millions of bushels)
(Millions of pairs)
(Millions of bushels)
(Millions of pairs)
Without Trade
Production 8 48 15 20
Consumption 8 48 15 20
With Trade
Production
Trade action
Consumption
Gains from Trade
Increase in Consumption