Question

3. Gains from trade Consider two neighboring island countries called Dolorium and Contente. They each have 4 milion labor hours available per month that they can use to produce jeans, corn, or a combination of both. The following table shows the amount of jeans or corn that can be produced using 1 hour of labor. Jeans Corn (Bushels per hour of labor) Country Dolorium Contente (Pairs per hour of labor) 8 Initially, suppose Contente uses 1 million hours of labor per month to produce jeans and 3 million hours per month to produce corn, while Dolorium uses 3 million hours of labor per month to produce jeans and 1 million hours per month to produce corn. Consequently, Dolorium produces 15 million pairs of jeans and 20 million bushels of corn, and Contente produces 8 million pairs of jeans and 48 million bushels of corn. 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 corn it produces Dolorium's opportunity cost of producing 1 pair of jeans is of corn, and Contente's opportunity cost of producing 1 pair of jeans is has a comparative advantage in the production of jeans, and of corn. Therefore, advantage in the production of corn. has a comparative 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 month, and the country that produces corn will produce million bushels per month

Answer 1

Dolorium's opportunity cost of producing 1 pair of jeans is 20/5 = 4 bushel of corn and Contente's opportunity cost of producing 1 pair of jeans is 16/8 =2 bushel of corn. Because Contente has a lower opportunity cost for the production of jeans. Therefore, Contente has a comparative advantage in the production of jeans and Dolorium has a comparative advantage in the production of corn

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 i.e Contente will produce (4)(8) = 32 million pairs per month And the country that produces corn i.e Dolorium will produce 4(20)=80 million bushels per month.

Suppose the country that produces corn trades 18 million pairs of jeans  to the other country in exchange for 54 million bushels of corn.

		DOLORIUM		CONTENTE
		Jeans (milions of Pairs)	Corn (Millions of bushels)	Jeans (Millions of pairs)	corn (Millions of bushels)
Without trade	Production	15	20	8	48
	Consumption	15	20	8	48
With Trade	Production	0	80	32	0
	Trade action	Import 18	Export 54	Export 18	Import 54
	Consumption	18	(80-54)= 26	(32-18)=14	54
Gains from trade	Increase in consumption	(18-15)=3	(26-22)=4	(14-8)=6	(54-48)=

When the two countries did not specialize ,the total production of jeans was 23 million pairs per month and the total production of corn was 68 millions bushels per month. Because of specialization ,the total production of jeans was 32 million pairs per month and total production of corn was 80 million bushels per month. This implies that because of specialization , total production of jeans  has increased by (32-23)=9 million pairs per month and total production of corn has increased by (80-68)=12 million bushels per month.