5. Terms of trade Suppose that France and Denmark both produce oil and wine. Fra

Question

5. Terms of trade

Suppose that France and Denmark both produce oil and wine. France's opportunity cost of producing a bottle of wine is 5 barrels of oil while Denmark's opportunity cost of producing a bottle of wine is 10 barrels of oil.

1.By comparing the opportunity cost of producing wine in the two countries, you can tell that ( Denmark, France) has a comparative advantage in the production of wine and ( France, Denmark) has a comparative advantage in the production of oil.

2.Suppose that France and Denmark consider trading wine and oil with each other. France can gain from specialization and trade as long as it receives more than ( 1 barrel, 1/10 barrel, 1/5 barrel, 5 barrels, 10 barrels) of oil for each bottle of wine it exports to Denmark. Similarly, Denmark can gain from trade as long as it receives more than ( 1 barrel, 1/10 barrel , 1/5 barrel, 5 barrel, 10 barrels) of wine for each barrel of oil it exports to France.

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

A.12 barrels of oil per bottle of wine

B.2 barrels of oil per bottle of wine

C.6 barrels of oil per bottle of wine

D.9 barrels of oil per bottle of wine

Explanation / Answer

1.By comparing the opportunity cost of producing wine in the two countries, you can tell that ( Denmark, France) has a comparative advantage in the production of wine and ( France, Denmark) has a comparative advantage in the production of oil.

2.Suppose that France and Denmark consider trading wine and oil with each other. France can gain from specialization and trade as long as it receives more than ( 1 barrel, 1/10 barrel, 1/5 barrel, 5 barrels, 10 barrels) of oil for each bottle of wine it exports to Denmark. Similarly, Denmark can gain from trade as long as it receives more than ( 1 barrel, 1/10 barrel , 1/5 barrel, 5 barrel, 10 barrels) of wine for each barrel of oil it exports to France.

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

A.12 barrels of oil per bottle of wine

B.2 barrels of oil per bottle of wine

C.6 barrels of oil per bottle of wine

D.9 barrels of oil per bottle of wine

(Since France would accept anything more than 5 barrels oil per bottle wine and Denmark would be willing to accept anything less than 10 barrels of oil per bottle of wine).

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