You are the Minister of Trade for a small island country in

You are the Minister of Trade for a small island country in the South Pacific with the annual production possibilities curve depicted below on the left. You are negotiating a deal with a neighboring island that has the annual PPC depicted below on the right:

Country 1: 500 Coconuts; 1500 Fish Country 2: 500 Coconuts; 2500 Fish

Suppose each island specialize and the joint production of fish and coconuts is equally split between the 2 economies. Calculate the gains from trade/specialization for each island individually and for the economy as a whole.

Solution

For Home country :

1 fish= 500/1500 = 0.33 Coconut production needs to be foregone,

for 1 Coconut= 3 fish have to be foregone

For neighbouring country:

1 Fish = 500/2500 = 0.2 units of coconut productuion sacrifice ,

1 Coconut= sacrificing 5 units of fish production

The trade will lead to lower consumption than earlier so the offer might not be good, rather it would be good to produce itself.