Question

Suppose that Italy and Switzerland consider trading wine and oil with each other. Italy can gain from specialization and trade as long as it receives more than1/5 barrel of oil for each bottle of wine it exports to Switzerland. Similarly, Switzerland can gain from trade as long as it receives more than1/5 bottle of wine for each barrel of oil it exports to Italy. Which of the following prices of trade (that is, the price of wine in terms of oil) would allow both Switzerland and Italy to gain from trade?
a. 4 barrels of oil per bottle of wine
b. 1 barrel of oil per bottle of wine
c. 7 barrels of oil per bottle of wine
d. 2 barrels of oil per bottle of wine

Answer 1

Answer:

All except ' 7 Barrels of oil per bottle of wine'

Explanation:

Italy & Switzerland can gain from specialising : If they get more than domestic trade off ratio i.e more than 1/5 or 0.20 units oil per unit wine & more than 1/5 or 0.20 units wine per unit oil.

• '4 Units Oil = 1 Unit Wine' implies '1 unit oil = 1/5 i.e 0.25 units Wine'. This is favourable term of trade for Switzerland & Italy, as they both get more than 1/5 or 0.20 units oil per unit wine & more than 1/5 or 0.20 units wine per unit oil
• '1 Unit Oil = 1 Unit Wine' is also favourable term of trade for Switzerland & Italy, as they both get > 1/5 or 0.20 units oil per unit wine & > 1/5 or 0.20 units wine per unit oil
• '2 units oil =  1 unit wine' implies ' 1 unit oil = 0.5 units wine'. It is is also favourable term of trade for Switzerland & Italy, as they both > than 1/5 or 0.20 units oil per unit wine & > 1/5 or 0.20 units wine per unit oil
• '7 units oil per unit wine' is favourable for Italy as it receives > 1/5 or 0.20 units oil per unit wine. But it is not favourable for Switzerland as it gets 1/7 = 0.14 units wine per unit oil, i.e < 1/5 or 0.20 units wine per unit oil.