Question

Suppose France can produce 9,000 potatoes or 3,000 lemons per day, and that Italy can produce 3,000 potatoes or 3,000 lemons per day. Which of the following statements in this context is true?a.Italy has a comparative advantage in producing potatoes.b.Italy would be willing to trade one lemon for anything greater than one potato.c.Both countries would be willing to trade at a rate of one lemon for one potato.d.France has a comparative advantage in producing lemons.e.France has an absolute advantage in producing lemons

Answer 1

Answer:

a. Italy has a comparative advantage in producing potatoes

Explanation:

Let us compute opportunity costs (OC).

In France,

OC of potato = 3000/9000

                      = 0.33 lemon

OC of lemon = 9000/3000

                      = 3 potato

In Italy,

OC of potato = 3000/3000

                      = 1 lemon

OC of lemon = 3000/3000

                     = 1 potato

France can produce potato at a lower OC than Italy, so France has comparative advantage in potato. Italy has a comparative advantage in producing lemons.

Trade is mutually beneficial if terms of trade (relative price) lies between the OC.

0.33 < Relative price of potato < 1 lemon, Or

1 potato < Relative price of lemon < 3 potato

Therefore, Italy has a comparative advantage in producing potatoes.