Question

 5. The price of trade

 Suppose that France and Austria both produce beer and olives. France's opportunity cost of producing a crate of olives is 4 barrels of beer while Austria's opportunity cost of producing a crate of olives is 9 barrels of beer.

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

 

 Suppose that France and Austria consider trading olives and beer with each other. France can gain from specialization and trade as long as it receives

 more than _______  of beer for each crate of olives it exports to Austria. Similarly, Austria can gain from trade as long as it receives more than _______  of olives for each barrel of beer it exports to France.

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

 1 barrel of beer per crate of olives

 2 barrels of beer per crate of olives

 5 barrels of beer per crate of olives

 6 barrels of beer per crate of olives

Answer 1

Since France has a lower opportunity cost of producing 1 crate of olive oil than Austria, we know that France has comparative advantage in the production of Olive oil and Austria has comparative advantage in production of Beer.

Trade price lies between two opportunity costs. Here, France can gain from trade as long as it receives more than 4 barrels of beer which is its opportunity cost of 1 crate of olive oil. Austria must receive more than 1/9 crates of olive oil for every barrel of beer exported.

The trade price lies between 4 barrels and 9 barrels of beer for 1 crate of olive oil. Hence select 5 barrels and 6 barrels.