Suppose that there are two states that do not trade: Iowa and Nebraska. Each state produces the same two goods: corn and wheat. For Iowa the opportunity cost of producing 1 bushel of wheat is 3 bushels of corn. For Nebraska the opportunity cost of producing 1 bushel of corn is 3 bushels of wheat. Present production is:


Iowa Nebraska
Wheat 20 million bushels 120 million bushels
Corn 120 million bushels 20 million bushels
 
Explain how, with trade, Nebraska can wind up with 40 million bushels of wheat and 120 bushels of corn while Iowa can wind up with 40 million bushels of corn and 120 million bushels of wheat.

. If the states ended up with the numbers given in a, how much would the trader get?

To understand how trade can lead to the desired outcome, we need to consider the concept of comparative advantage. Comparative advantage refers to the ability of a country or state to produce a good at a lower opportunity cost compared to another country or state.

In this case, we can see that Iowa's opportunity cost of producing 1 bushel of wheat is 3 bushels of corn, while Nebraska's opportunity cost of producing 1 bushel of corn is 3 bushels of wheat. This means that Iowa is relatively better at producing corn compared to wheat, while Nebraska is relatively better at producing wheat compared to corn.

Now, let's analyze how trade can benefit both states:

1. Nebraska has a comparative advantage in producing wheat: Since Nebraska's opportunity cost of producing corn is higher than Iowa's, it implies that Nebraska can produce wheat more efficiently than Iowa. Therefore, Nebraska should focus on producing more wheat.

2. Iowa has a comparative advantage in producing corn: Conversely, Iowa has a lower opportunity cost of producing corn, making it more efficient in corn production than Nebraska. Therefore, Iowa should focus on producing more corn.

Now, let's see how the desired outcome is achieved through trade:

Nebraska, being more efficient in wheat production, can produce additional 40 million bushels of wheat. To achieve this, Nebraska can divert some of its resources, previously used for corn production, into wheat production.

Similarly, Iowa, being more efficient in corn production, can produce an additional 40 million bushels of corn. For this, Iowa can redirect some resources that were previously used for wheat production towards corn production.

With the increased production, Nebraska can trade 40 million bushels of wheat to Iowa in exchange for 40 million bushels of corn. Since Nebraska values corn more than wheat due to its higher opportunity cost, it is willing to trade a larger quantity of wheat for a smaller quantity of corn.

In the end, Nebraska winds up with 40 million bushels of wheat and 120 million bushels of corn, and Iowa ends up with 40 million bushels of corn and 120 million bushels of wheat.

Now, let's calculate what the trader receives:

The trader facilitates the trade between Iowa and Nebraska and earns a profit or commission based on the quantity of goods traded. In this case, the trader would receive a commission based on the quantity of wheat and corn exchanged between the two states, which is 40 million bushels of each. The exact amount the trader receives would depend on the agreed-upon terms and rates of commission.