Question

Suppose that Spain and Austria both produce oil and cheese. Spain's opportunity cost of producing a pound of cheese is 4 barrels of oil while Austria's opportunity cost of producing a pound of cheese is 10 barrels of oil. By comparing the opportunity cost of producing cheese in the two countries, you can tell that has a comparative advantage in the production of cheese and has a comparative advantage in the production of oil. Suppose that Spain and Austria consider trading cheese and oil with each other. Spain can gain from specialization and trade as long as it receives more than of oil for each pound of cheese it exports to Austria. Similarly, Austria can gain from trade as long as it receives more than of cheese for each barrel of oil it exports to Spain. Based on your answer to the last question, which of the following prices of trade (that is, price of cheese in terms of oil) would allow both Austria and Spain to gain from trade? Check all that apply. 1 barrel of oil per pound of cheese 16 barrels of oil per pound of cheese 9 barrels of oil per pound of cheese 7 barrels of oil per pound of cheese

Answer 1

Explanation:

Spain's opportunity cost of producing a pound of cheese is

= 4 barrels of oil

Austria's opportunity cost of producing a pound of cheese is

= 10 barrels of oil

Spain's opportunity cost of producing a barrel of oil is

= $\frac{1}{4}$

= 0.25

Austria's opportunity cost of producing a barrel of oil is

= $\frac{1}{10}$

= 0.1

A country is said to be having a comparative advantage in the production of a commodity if it has a relatively lower opportunity cost of production.

Here, Spain has a lower opportunity cost of producing cheese, so it has a comparative advantage in producing cheese.  

Similarly, Austria has a lower opportunity cost of producing oil, so it has a comparative advantage in producing oil.

Spain can gain from trade as long as it is getting more than 4 barrels of oil for a pound of cheese.  

While Austria can gain from trade as long as it is getting more than 0.125 pounds of cheese for a barrel of oil.

Both will gain from trade if the price of the trade is  9 barrels of oil per pound of cheese and 7 barrels of oil per pound of cheese.

Spain will not accept 1 barrel of oil per pound of cheese and Austria will not pay 16 barrels of oil per pound of cheese.