3. Terms of trade Suppose that Portugal and Switzerland both produce beer and ol

Question

3. Terms of trade Suppose that Portugal and Switzerland both produce beer and olives. Portugal's opportunity cost of producing a crate of olives is 5 barrels of beer while Switzerland's opportunity cost of producing a crate of olives is 11 barrels of beer. By comparing the opportunity cost of producing olives in the two countries, you can tell that production of olives and has a comparative advantage in the has a comparative advantage in the production of beer. Suppose that Portugal and Switzerland consider trading olives and beer with each other. Portugal can gain from specialization and trade as long as it receives more than receives more tharn of beer for each crate of olives it exports to Switzerland. Similarly, Switzerland can gain from trade as long as it of olives for each barrel of beer it exports to Portugal. Based on your answer to the last question, which of the following terms of trade (that is, price of olives in terms of beer) would allow both Switzerland and Portugal to gain from trade? Check all that apply. 1 barrel of beer per crate of olives 9 barrels of beer per crate of olives 2 barrels of beer per crate of olives 17 barrels of beer per crate of olives

Explanation / Answer

By comparing the opportunity cost of producing olives in the two countries, Portugal has lower opportunity cost of producing olives, Therefore, Portugal has a comparative advantage in the production of olives. And Switzerland has a lower opportunity in the production of beer, therefore, Switzerland has a comparative in the production of beer.

Suppose that Portugal and Switzerland consider trading olives and beer with each other. Portugal can gain from specialization and trade as long as it receives more than 5 barrels of beer for each crate of olives it exports to Switzerland. Because Portugal's opportunity cost of producing a crate of olives is 5 barrels of beer.Therefore, it can import more than 5 barrels of beer for each crate of olives it exports, it will be better off importing beer than producing it domestically.

Similarly, Switzerland can gain from trade as long it receives more than 1/11 crate of olive for each barrel of beer it exports to Portugal. Because Switzerland's opportunity cost of producing a crate of olives is 11 barrel of beer. This implies that for each barrel of beer, it must give up 1/11 of a crate of olives . Therefore, if it can import more than 1/11 of a crate of olives for each barrel of beer it exports, it will be better off importing olives than producing domestically.

Portugal will gain from trade if it gets more than 5 barrels of oil for each crate of olives it exports. Similarly, Switzerland will trade beer only if it gets more than 1/11 crate of olives for each barrel of beer it exports. It means that Switzrland is willing to trade up to 11 barrels of beer for each crate of olives it imports.

Therefore, any price ratio that involves olives selling for between 5 and 11 barrels of beer per crate of olives will benefit both countries. Any price below 5 barrels of beer per crate of olives would benefit Switzerland but not Portugal. Similarly, any price above 11 barrels of beer per crate of olives would benefit Portugal but not Switzerland.

Hence, Option(B) i.e 9 barrels of beer per crate of olives is correct . Because it lies between 5 and 11 barrels of beer per crate of olives.

Related Questions

Navigate

• Browse (All)
• Browse 3
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.