Question

Suppose that Italy and Denmark both produce beer and shoes. Italy's opportunity cost of producing a pair of shoes is 4 barrels of beer while Denmark's opportunity cost of producing a pair of shoes is 11 barrels of beer. 

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

Suppose that Italy and Denmark consider trading shoes and beer with each other. Italy can gain from specialization and trade as long as it receives more than _______  of beer for each pair of shoes it exports to Denmark. Similarly, Denmark can gain from trade as long as it receives more than _______  of shoes 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 shoes in terms of beer) would allow both Denmark and Italy to gain from trade? Check all that apply. 

• 9 barrels of beer per pair of shoes 

• 1 barrel of beer per pair of shoes 

• 3 barrels of beer per pair of shoes 

• 7 barrels of beer per pair of shoes

Answer 1

The opportunity cost of producing a pair of shoes = 4 beer [ for Italy ]

opportunity cost of producing a beer = 1/4 pair of shoes

while opportunity cost of producing a pair of shoes = 11 beer [ for Denmark ]

opportunity cost of producing a beer = 1/11 pair of shoes

As the opportunity cost of producing shoes is less for Italy so Italy has comparative advantage in production shoes and Denmark has a comparative advantage in production of beer.

Italy can gain from specialization and trade as long as it receives more than 4 of beer for each pair of shoes. Similarly, Denmark can gain from specialization and trade as long as it receives more than 1/11 pair of shoes for each barrel of beer.

Explanation:

A country will gain from trade if it receive the good more than its opportunity cost of producing that good, so here Italy will gain if it get more than its opportunity cost of producing each pair of shoes i.e, 4 barrel of beer and Denmark will gain if it get more than its opportunity cost of producing each barrel of beer i.e, 1/11 pair of shoes.

So the price of shoes in term of beer must be in between 4 and 11 barrel of beer so that bot country can get gain from trade.

All apply are:

9 barrels of beer per pair of shoes

7 barrels of beer per pair of shoes.