ECO101H1 Lecture Notes - Lecture 2: Comparative Advantage, Absolute Advantage, Opportunity Cost
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3. Gains from trade
Consider two neighboring island countries called Felicidad and Arcadia. They each have 4 million labor hours available per month that they can use to produce jeans, rye, or a combination of both. The following table shows the amount of jeans or rye that can be produced using 1 hour of labor.
| Country | Jeans | Rye |
|---|---|---|
| (Pairs per hour of labor) | (Bushels per hour of labor) | |
| Felicidad | 8 | 32 |
| Arcadia | 12 | 24 |
Initially, suppose Arcadia uses 1 million hours of labor per month to produce jeans and 3 million hours per month to produce rye, while Felicidad uses 3 million hours of labor per month to produce jeans and 1 million hours per month to produce rye. Consequently, Felicidad produces 24 million pairs of jeans and 32 million bushels of rye, and Arcadia produces 12 million pairs of jeans and 72 million bushels of rye. 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 rye it produces.
Felicidad's opportunity cost of producing 1 pair of jeans is _____ of rye, and Arcadia's opportunity cost of producing 1 pair of jeans is _____ of rye. Therefore, _____ has a comparative advantage in the production of jeans, and ____ has a comparative advantage in the production of rye.
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 ______ millions pairs per month, and the country that produces rye will produce ______ millions bushels per month.
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 26 million pairs of jeans to the other country in exchange for 78 million bushels of rye.
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 36 million pairs per month, and the total production of rye was 104 million bushels per month. Because of specialization, the total production of jeans has increased by ____ million pairs per month, and the total production of rye has increased by _____ million bushels per month.
Because the two countries produce more jeans and more rye under specialization, each country is able to gain from trade.
Calculate the gains from tradeâthat 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 | |||
|---|---|---|---|---|
| Jeans | Rye | Jeans | Rye | |
| (Millions of pairs) | (Millions of bushels) | (Millions of pairs) | (Millions of bushels) | |
| Without Trade | ||||
| Production | 24 | 32 | 12 | 72 |
| Consumption | 24 | 32 | 12 | 72 |
| With Trade ? ? ? ? | ||||
| Production | ? | ? | ? | ? |
| Trade action | ? | ? | ? | ? |
| Consumption | ? | ? | ? | ? |
| Gains from Trade ? ? ? ? | ||||
| Increase in Consumption | ? | ? | ? | ? |
3. Gains from trade
Consider two neighboring island countries called Euphoria and Contente. 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.
| Country | Rye | Jeans |
|---|---|---|
| (Bushels per hour of labor) | (Pairs per hour of labor) | |
| Euphoria | 8 | 32 |
| Contente | 12 | 24 |
Initially, suppose Contente uses 1 million hours of labor per week to produce rye and 3 million hours per week to produce jeans, while Euphoria uses 3 million hours of labor per week to produce rye and 1 million hours per week to produce jeans. Consequently, Euphoria produces 24 million bushels of rye and 32 million pairs of jeans, and Contente produces 12 million bushels of rye 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 rye and jeans it produces.
Euphoria's opportunity cost of producing 1 bushel of rye isï¼ ï¼ of jeans, and Contente's opportunity cost of producing 1 bushel of rye isï¼ ï¼ of jeans. Therefore, ï¼ ï¼has a comparative advantage in the production of rye, andï¼ ï¼ 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 rye will produce ï¼ ï¼million bushels per week, and the country that produces jeans will produce ï¼ ï¼ million pairs per week.
In the following table, enter each country's prod uction decision on the third row of the table (marked "Production").
Suppose the country that produces rye trades 26 million bushels of rye 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 rye 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 rye has increased byï¼ ï¼million bushels per week, and the total production of jeans has increased by ï¼ ï¼million pairs 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 tradeâthat 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").
| Euphoria | Contente | |||
|---|---|---|---|---|
| Rye | Jeans | Rye | Jeans | |
| (Millions of bushels) | (Millions of pairs) | (Millions of bushels) | (Millions of pairs) | |
| Without Trade | ||||
| Production | 24 | 32 | 12 | 72 |
| Consumption | 24 | 32 | 12 | 72 |
| With Trade | ||||
| Production | ||||
| Trade action | ||||
| Consumption | ||||
| Gains from Trade | ||||
| Increase in Consumption | ||||