Suppose that Italy and Sweden both produce jeans and stained glass. Italy\'s opp

Question

Suppose that Italy and Sweden both produce jeans and stained glass. Italy's opportunity cost of producing a pane of stained glass is 4 pairs of jeans while Sweden's opportunity cost of producing a pane of stained glass is 10 pairs of jeans. By comparing the opportunity cost of producing stained glass in the two countries, you can tell that has a comparative advantage in the production of stained glass and has a comparative advantage in the production of jeans. Suppose that Italy and Sweden consider trading stained glass and jeans with each other. Italy can gain from specialization and trade as long as it receives more than of jeans for each pane of stained glass it exports to Sweden. Similarly, Sweden can gain from trade as long as it receives more than of stained glass for each pair of jeans it exports to Italy. Based on your answer to the last question, which of the following terms of trade (that is, price of stained glass in terms of jeans) would allow both Sweden and Italy to gain from trade? Check all that apply. 18 pairs of jeans per pane of stained glass 2 pairs of jeans per pane of stained glass 8 pairs of jeans per pane of stained glass 1 pair of jeans per pane of stained glass

Explanation / Answer

(1) Italy has comparative advantage in stained glass (since Italy can produce stained glass at a lower opportunity cost than Sweden can: 4 < 10) and Sweden has comparative advantage in producing jeans.

(2) Italy can gain from trade as long as it receives more than 4 jeans (since trade is beneficial only if terms of trade lies between opportunity cost of the good in both countries).

(3) Sweden can gain from trade as long as it receives more than 0.10 stained glass (= 1/10) (since trade is beneficial only if terms of trade lies between opportunity cost of the good in both countries).

(4) Acceptable terms of trade (TOT) will be:

4 jeans < TOT for stained glass < 10 jeans, and

0.10 stained glass < TOT for jeans < 0.25 stained glass. Therefore,

Following terms of trade will allow gains from trade.

- 8 pairs of jeans per pane of stained glass

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