Question

Suppose that Italy and Germany both produce beer and wine. Italy's opportunity cost of producing a bottle of wine is 4 barrels of beer while Germany's opportunity cost of producing a bottle of wine is 10 barrels of beer.

By comparing the opportunity cost of producing wine in the two countries, you can tell that............ has a comparative advantage in the production of wine and......... has a comparative advantage in the production of beer.

Suppose that Italy and Germany consider trading wine and beer with each other. Italy can gain from specialization and trade as long as it receives more than.............. barrels   of beer for each bottle of wine it exports to Germany. Similarly, Germany can gain from trade as long as it receives more than......... bottle   of wine for each barrel of beer it exports to Italy.

Based on your answer to the last question, which of the following prices of trade (that is, price of wine in terms of beer) would allow both Germany and Italy to gain from trade? Check all that apply.

7 barrels of beer per bottle of wine

2 barrels of beer per bottle of wine

9 barrels of beer per bottle of wine

16 barrels of beer per bottle of wine

Answer 1

Using the concept of comparative advantage based in opportunity costs of production & then the terms of trade approach of benefit from mutual trade between two nations