3. Gains from trade

Consider two neighboring island countries called Felicidad and Arcadia. 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.

CountryJeansCorn(Pairs per hour of labor)(Bushels per hour of labor)Felicidad520Arcadia816Initially, 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, Felicidad produces 15 million pairs of jeans and 20 million bushels of corn, and Arcadia 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.

Felicidad's opportunity cost of producing 1 pair of jeans is4 bushels of corn, and Arcadia's opportunity cost of producing 1 pair of jeans is2 bushels of corn. Therefore,Felicidad has a comparative advantage in the production of jeans, andArcadia 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, producingonlythat good. In this case, the country that produces jeans will producemillionpairs per week, and the country that produces corn will producemillionbushels 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 jeans trades 18 million pairs of jeans to the other country in exchange for 54 million bushels of corn.

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 jeans was 23 million pairs per week, and the total production of corn was 68 million bushels per week. Because of specialization, the total production of jeans has increased bymillionpairs per week, and the total production of corn has increased bymillionbushels per week.

Because the two countries produce more jeans and more corn 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

Arcadia

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