Question

6. Terms of trade Suppose that Portugal and Sweden both produce oil and cheese. Portugal’s opportunity cost of producing a pound of cheese is 5 barrels of oil, while Sweden’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 Portugal and Sweden consider trading cheese and oil with each other. Portugal can gain from specialization and trade as long as it receives more than of oil for each pound of cheese it exports to Sweden. Similarly, Sweden can gain from trade as long as it receives more than of cheese for each barrel of oil it exports to Portugal. Based on your answers to the previous question, which of the following terms of trade (that is, price of cheese in terms of oil) would allow both Sweden and Portugal to gain from trade? Check all that apply.
1 barrel of oil per pound of cheese
7 barrels of oil per pound of cheese
4 barrels of oil per pound of cheese
11 barrels of oil per pound of cheese

Answer 1

Answer:

7 barrels of oil per pound of cheese

Explanation:

Sweden has a comparative advantage in producing oil while Portugal has a competitive advantage in producing cheese.

In order for the trade to be beneficial to Sweden, it must give up less than 10 barrels of oil for a pound of cheese.

In order for the trade to be beneficial to Portugal, it must accept more than 5 barrels of oil for a pound of cheese.

Therefore, the number of pounds of cheese that would allow both countries to gain is:

$5 < n$

The only answer option that fits within the interval is 7 barrels of oil per pound of cheese.