Economics Homework Help

How to do a “gains from trade” exercise:

EXERCISE A: Remember the goal: You want to prove Ricardo’s assertion that by specializing in their area of comparative advantage and trading, two countries (or individuals) can both end up better off. You can prove this if you can show that after specializing and trading, each country consumes at least as much of both products, and more of at least one product.You do this in a three-step process.Step 1: Figure out which country has the comparative advantage in which product – you do this by figuring out the opportunity cost of each product for each country. The country with a lower opportunity cost for a particular product has the comparative advantage in that product. ?Remember that the opportunity cost of increasing production of one product by one unit is measured by the amount of the other product that must be sacrificed.Step 2: Have each country specialize in producing the product in which it has the comparative advantage.?Make sure that after specialization, the total production of each product is at least as much as it was before specialization. (In other words, for each product, add together the amounts produced by the two countries. The pre-specialization total can’t be larger than the post-specialization total for either product.)Step 3: Propose a trade between the two countries that results in both countries having at least as much to consume of each product as they did originally, and more of at least one of the products.

EXERCISE B: Below are PPFs for the nations of Transylvania and Booville. The dots show each country’s annual production and consumption of pumpkins and vampire blood. The two nations want to start to trade with each other. Fill in numbers and circle choices below to explain how trade could make it possible for both countries to consume at least as much of each product as they are currently consuming, and more of at least one product.

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