Question

Suppose that Spain and Denmark both produce jeans and olives. Spain's opportunity cost of producing a crate of olives is 3 pairs of jeans while Denmark's opportunity cost of producing a crate of olives is 11 pairs of jeans.
By comparing the opportunity cost of producing olives in the two countries, you can tell that Spain has a comparative advantage in the production of olives and Denmark has a comparative advantage in the production of jeans.
Suppose that Spain and Denmark consider trading olives and jeans with each other. Spain can gain from specialization and trade as long as it receives more than 3 pairs of jeans for each crate of olives it exports to Denmark. Similarly, Denmark can gain from trade as long as it receives more than 1/11 crate of olives for each pair of jeans it exports to Spain.
Based on your answer to the last question, which of the following prices of trade (that is, price of olives in terms of jeans) would allow both Denmark and Spain to gain from trade? Check all that apply.

a. 2 pairs of jeans per crate of olives
b. 6 pairs of jeans per crate of olives
c. 4 pairs of jeans per crate of olives
d. 13 pairs of jeans per crate of olives

Answer 1

Answer:

b. 6 pairs of jeans per crate of olives; and

c. 4 pairs of jeans per crate of olives

Explanation:

                 Olives       Jeans      Trade off Ratio (Olives:Jeans)

Spain            1               3            1:3 or 0.33:1       (1/3 = 0.33)

Denmark      1              11            1:11 or 0.09:1     (1/11= 0.09)

Spain & Denmark have less opportunity cost & hence comparative advantage than each other,  in Olive & Jeans respectively.

Spain will export Olives to Denmark (importer). Denmark will export Jeans to Spain (Importer). Trade will be gainful if they get exchange ratio better than domestic exchange ratio.

• '2 jeans pairs per olive crate' not gainful trade ratio for Spain, as it is getting more i.e 3 jeans pair per olive crate at its own domestic ratio.

• '13 jeans per olive' not gainful for Denmark, as 0.07 = (1/13) olive per jeans is worse than its own domestic ratio i.e 0.09 = (1/11) olive per jeans  

'4 jeans pairs per olive crate'  is gaining trade ratio for:

• Spain: As it gets 4 i.e more than 3 pairs of jeans per olive crate
• Denmark : As it gets 0.25 = (1/4) i.e more than 0.09 olive crates per pair of jeans

'6 jeans pairs per olive crate' is gaining trade ratio for:

• Spain: As it gets 6 i.e more than 3 pairs of jeans per olive crate
• Denmark : As it gets 0.16 = (1/6) i.e more than 0.09 olive crates per pair of jeans

Both of them are gainful trade ratios, but:

• 1olive:4 jeans is more gainful for Denmark, as it is gaining relatively more than domestic exchange rate (0.25 is more > 0.09 than 4 > 3).  
• 1olive:6jeans is more gainful for Spain as it is gaining relatively more than domestic exchange rate (6 is more > 3 than 0.16 > 0.09)