Question

Suppose that Italy and Sweden both produce jeans and stained glass. Italy's opportunity cost of producing a pane of stained glass is 4 pairs of jeans while Sweden's opportunity cost of producing a pane of stained glass is 10 pairs of jeans. By comparing the opportunity cost of producing stained glass in the two countries, you can tell that has a comparative advantage in the production of stained glass and has a comparative advantage in the production of jeans. Suppose that Italy and Sweden consider trading stained glass and jeans with each other. Italy can gain from specialization and trade as long as it receives more than of jeans for each pane of stained glass it exports to Sweden. Similarly, Sweden can gain from trade as long as it receives more than of stained glass for each pair of jeans it exports to Italy. Based on your answer to the last question, which of the following terms of trade (that is, price of stained glass in terms of jeans) would allow both Sweden and Italy to gain from trade? Check all that apply.
(A) 18 pairs of jeans per pane of stained glass
(B) 2 pairs of jeans per pane of stained glass
(C) 8 pairs of jeans per pane of stained glass
(D) 1 pair of jeans per pane of stained glass

Answer 1

Answer:

The correct answer is option C.

Explanation:

Italy and Sweden both produce jeans and stained glass.

Italy's opportunity cost of producing a pane of stained glass  

= 4 pairs of jeans  

Sweden's opportunity cost of producing a pane of stained glass  

= 10 pairs of jeans

Since Italy has a lower opportunity cost of producing glass, so we can say that it has a comparative advantage in the production of glass.  

Italy's opportunity cost of producing a pair of jeans  

= $\frac{1}{4}$

= 0.25

Sweden's opportunity cost of producing a pair of jeans  

= $\frac{1}{10}$

= 0.1

Sweden has a lower opportunity cost in the production of jeans, so it has a comparative advantage in the production of jeans.  

So, Italy will produce and export glass and Sweden will produce and export jeans.  

Both the countries will gain from trade if the trade price lies between their opportunity cost.  

So the trade price will be 8 pairs of jeans per pane of stained glass.