Question

5. Terms of trade Suppose that France and Switzerland both produce jeans and olives. France's opportunity cost of producing a crate of olives is 3 pairs of jeans while Switzerland's opportunity cost of producing a crate of olives is 11 pairs of jeans. 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 jeans. Suppose that France and Switzerland consider trading olives and jeans with each other. France can gain from specialization and trade as long as it receives more than of jeans for each crate of olives it exports to Switzerland. Similarly, Switzerland can gain from trade as long as it receives more than of olives 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 olives in terms of jeans) would allow both Switzerland and France to gain from trade? Check all that apply. 1 pair of jeans per crate of olives 2 pairs of jeans per crate of olives 6 pairs of jeans per crate of olives 4 pairs of jeans per crate of olives

Answer 1

France opportunity cost of producing a crate of olives = 3 pairs of jeans.

Switzerland opportunity cost of producing a crate of olives = 11 pair of jeans.

By comparing the opportunity cost of producing olives in two countries, you can tell that France has comparative advantage in the production of and Switzerland has comparative advantage in the production of jeans.

Note: Lower opportunity cost means comparative advantage.

Suppose that France and Switzerland consider trading olives and jeans with each other. France can gain from specialization and trade as long as it recieves more than 3 pair of jeans for each crate of olives it exports to Switzerland.

Similarly, Switzerland can gain from trade as long as it recieves more than 1/11 crates of olives for each pair of jeans it export to France.

Price of olives in terms of pair of jeans.

3 pairs of jeans < 1 crate of olives < 11 pairs of jeans.

The above stated price range will generate profit for both countries.

Because France would not be ready to accept less than 3 pairs of jeans for 1 crate of olives from switzerland, because France can make 3 pairs of jeans by sacrifing 1 crate of olives by their own.

Similarly Switzerland would not be ready to give more than 11 pairs of jeans for 1 crates of olives to France.

Hence any price which lies in the above price range would benefited both countries.

Answer: 6 pairs of jeans per crate of olives.

4 pairs of jeans per crate of olives.