3. Gains from trade

Consider two neighboring island countries called Felicidad and Bellissima. 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.

CountryRyeJeans(Bushels per hour of labor)(Pairs per hour of labor)Felicidad520Bellissima816Initially, suppose Bellissima uses 1 million hours of labor per week to produce rye and 3 million hours per week to produce jeans, while Felicidad uses 3 million hours of labor per week to produce rye and 1 million hours per week to produce jeans. Consequently, Felicidad produces 15 million bushels of rye and 20 million pairs of jeans, and Bellissima produces 8 million bushels of rye and 48 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.

Felicidad's opportunity cost of producing 1 bushel of rye is2 pairs of jeans, and Bellissima's opportunity cost of producing 1 bushel of rye is2 pairs 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, producingonlythat good. In this case, the country that produces rye will producemillionbushels per week, and the country that produces jeans will producemillionpairs 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 bymillionbushels per week, and the total production of jeans has increased bymillionpairs 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 tradethat 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").

Felicidad

Bellissima

RyeJeansRyeJeans(Millions of bushels)(Millions of pairs)(Millions of bushels)(Millions of pairs)Without TradeProduction1520848Consumption1520848With TradeProductionTrade action ConsumptionGains from TradeIncrease in Consumption