3. Gains from trade
Consider two neighboring island countries called Dolorium and Arcadia. They each have 4 million labor hours available per week that they can use to produce corn, jeans, or a combination of both. The following table shows the amount of corn or jeans that can be produced using 1 hour of labor.
CountryCornJeans(Bushels per hour of labor)(Pairs per hour of labor)Dolorium832Arcadia1224Initially, suppose Arcadia uses 1 million hours of labor per week to produce corn and 3 million hours per week to produce jeans, while Dolorium uses 3 million hours of labor per week to produce corn and 1 million hours per week to produce jeans. Consequently, Dolorium produces 24 million bushels of corn and 32 million pairs of jeans, and Arcadia produces 12 million bushels of corn and 72 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 corn and jeans it produces.
Dolorium’s opportunity cost of producing 1 bushel of corn is4 pairs of jeans, and Arcadia’s opportunity cost of producing 1 bushel of corn is2 pairs of jeans. Therefore,Arcadia has a comparative advantage in the production of corn, andDolorium 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 corn will producemillion bushels per week, and the country that produces jeans will producemillion 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 corn trades 26 million bushels of corn to the other country in exchange for 78 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 corn was 36 million bushels per week, and the total production of jeans was 104 million pairs per week. Because of specialization, the total production of corn has increased bymillion bushels per week, and the total production of jeans has increased bymillion pairs per week.
Because the two countries produce more corn 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”).
CornJeansCornJeans(Millions of bushels)(Millions of pairs)(Millions of bushels)(Millions of pairs)Without TradeProduction24321272Consumption24321272With TradeProductionTrade action ConsumptionGains from TradeIncrease in Consumption
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