Question

Bill and Fred bake cakes and pies. Bill's opportunity cost of baking 1 pie is 3 cakes. Fred's opportunity cost of baking 1 pie is 5 cakes. If both parties are to benefit from trade then we can expect 1 pie to sell for:

Answer 1

Answer

It is given that Bill's opportunity cost of baking 1 pie is 3 cakes. Fred's opportunity cost of baking 1 pie is 5 cakes. Hence Opportunity cost of Producing pie is lesser for Bill and hence, He has comparative advantage in producing pie and hence will specialize in producing Pie. Hence Bill will be benefited if in exchange in 1 Pie he gets more than 3 cakes. Fred cost of making 1 pie is 5 cakes and hence in order to produce 1 pie he has to sacrifice 5 cakes(or he has to pay 5 cakes for 1 pie). Thus he will be benefited from trade if he pays lesser than 5 cakes for 1 pie.

Hence we have :

Bill will get benefited from trade If 1P > 3C and Fred will get benefited from trade If 1P < 5C

Hence Both will be benefited from trade if 3C < 1P < 5C.

Which means both will be benefited from trade if 1 pie is to sell for more than 3 Cakes and less than 5 Cakes like 1 Pie is exchanged for 4 Cakes. (thus If both parties are to benefit from trade then we can expect 1 pie to sell for 4 Cakes)