Question

3. Comparative advantage and gains from trade Consider two neighboring island countries called Arcadia and Felicidad. They each have 4 million labor hours available per week 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 Country Pairs per hour of labor) (Bushels per hour of labor) Arcadia Felicidad 12 24 8 32 Initially, suppose Arcadia uses 1 million hours of labor per week to produce jeans and 3 million hours per week to produce corn, while Felicidad uses 3 million hours of labor per week to produce jeans and 1 million hours per week to produce corn. Consequently, Arcadia produces 12 million pairs of jeans and 72 million bushels of corn, and Felicidad produces 24 million pairs of jeans and 32 millon 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 Arcadia's opportunity cost of producing 1 pair of jeans is 1/2 bushel ▼ or corn, and Felicidad's opportunity cost of producing 1 pair of Jeans is of corn. Therefore has a comparative advantage in the production of jeans, and 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 will produce million pairs per week, and the country that produces corn will produce million bushels per week

Answer 1

Arcadias opportunity cost of producing 1 pair of jeans is 24/12 = 2 bushels of corn and Felicidad's opportunity cost of producing 1 pair of jeans is 32/8=4 bushels of corn. Because Arcadia has a lower opportunity cost for the production of jeans. Therefore, Arcadia has a comparative advantage in the production of jeans and Felicidad 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 Arcadia will produce (4)(12) = 48 million pairs per week And the country that produces corn  i.e Felicidad will produce 4(32)=128 million bushels per week.

Suppose the country that produces jeans  trades 26 million pairs of jeans to the other country in exchange for 78 million bushels of corn.

		ARCADIA		FELICIDAD
		Jeans (milions of pairs)	Corn (Millions of bushels)	Jeans (Millions of pairs)	Corn (Millions of bushels)
Without trade	Production	12	72	24	32
	Consumption	12	72	24	32
With Trade	Production	48	0	0	128
	Trade action	Export 26	Import 78	Import 26	Export 78
	Consumption	(48-26)=22	78	26	(128-78)=50
Gains from trade	Increase in consumption	(22-12)=10	(78-72)=6	(26-24)=2	(50-32)=18

When the two countries did not specialize ,the total production of jeans was 36 million pairs per week and the total production of corn was 104 million bushels per week.. Because of specialization ,the total production of jeans was 48 million pairs per week and total production of corn was 128 million bushels  per week. This implies that because of specialization , total production of jeans has increased by (48-36)=12 million pairs per week and total production of corn  has increased by (128-104)= 24 million bushels per week.