Question

 5. The price of trade

 Suppose that France and Sweden both produce Jeans and cheese. France's opportunity cost of producing a pound of cheese is 5 pairs of jeans while Sweden's opportunity cost of producing a pound of cheese is 10 pairs of jeans.

 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 seans.

 Suppose that France and Sweden consider trading cheese and jeans with each other. France can gain from specialization and trade as long as it receives more than _______  of jeans 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 pair of jeans it exports to France.

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

•  9 pairs of jeans per pound of cheese

•  3 pairs of jeans per pound of cheese

•  15 pains of jeans per pound of cheese

•  1 pair of jeans per pound of cheese

 

Answer 1

(1) France has comparative advantage in cheese (since France can make cheese at lower opportunity cost), so Sweden has comparative advantage in jeans.

(2) Trade is beneficial as long as terms of trade (TOT) lies between opportunity cost (OC) in both countries. So

France can gain as long as it receives more than 5 jeans and Sweden can gain as long as it receives more than (1/10) cheese.

(3) Acceptable TOT are: 5 jeans < TOT of 1 cheese < 10 jeans. So following TOT is acceptable:

- 9 pairs of jeans per pound of cheese