Question

Suppose that France and Denmark both produce oil and wine. France's opportunity cost of producing a bottle of wine is 5 barrels of oil while Denmark's opportunity cost of producing a bottle of wine is 10 barrels of oil.
1. By comparing the opportunity cost of producing wine in the two countries, you can tell that _________ ( Denmark, France) has a comparative advantage in the production of wine and __________ (France, Denmark) has a comparative advantage in the production of oil.
2. Suppose that France and Denmark consider trading wine and oil with each other. France can gain from specialization and trade as long as it receives more than _________ (1 barrel, 1/10 barrel, 1/5 barrel, 5 barrels, 10 barrels) of oil for each bottle of wine it exports to Denmark. Similarly, Denmark can gain from trade as long as it receives more than ________ (1 barrel, 1/10 barrel , 1/5 barrel, 5 barrel, 10 barrels) of wine for each barrel of oil it exports to France.
3. Based on your answer to the last question, which of the following terms of trade (that is, price of wine in terms of oil) would allow both Denmark and France to gain from trade? Check all that apply.
A. 12 barrels of oil per bottle of wine
B. 2 barrels of oil per bottle of wine
C. 6 barrels of oil per bottle of wine
D. 9 barrels of oil per bottle of wine

Answer 1

Answer: 1 Denmark has comparative advantage in the production of oil,while France has comparative advantage in the production of wine. 2 France gain 5 barrel of oil for each bottle of wine it export to Denmark, while Denmark will gain 10 barrels of wine for each barrel of oil it export to France 3. The answer is B 2 barrels of oil per bottle of wine

Explanation:

1 . The law of comparative cost advantage states that countries should specialize in the production of commodities in which they have comparative advantage over the others.each countries tries to specialize in the production of those commodities in respect of which it has the greatest relative advantage over others. For France the opportunity cost of producing wine over oil is 5 ÷10 = 1/2, for Denmark the opportunity cost of producing oil over wine is 10 ÷ 5 = 2

2. The gain of the specialization if the two countries consider trading wine and oil with each other is that France will gain 5 barrels of oil for each bottle of wine it export to Denmark, likewise Denmark will gain 10 barrels of wine for each barrel of oil it export to France.

3. The term of trade measures the amount of import that are exchanged in return for export.The term of trade are the price ratio between import and export. Changes in the term of trade can be calculated as

Term of trade = Price index of export/ price index of import × 100

Or Px/Pm × 100/1

The term of trade in this case is 10÷ 5 = 2 Therefore both Denmark and France will gain from trade 2barrels of oil per bottle of wine