Question

Suppose that Italy and Germany both produce beer and cheese. Italy's opportunity cost of producing a pound of cheese is 5 barrels of beer while Germany's opportunity cost of producing a pound of cheese is 10 barrels of beer. By comparing the opportunity cost of producing cheese in the two countries, you can tell that has a comparative advantage in the production of cheese and has a comparative advantage in the production of beer. Suppose that Italy and Germany consider trading cheese and beer with each other. Italy can gain from specialization and trade as long as it receives more than of beer for each pound of cheese it exports to Germany. Similarly, Germany can gain from trade as long as it receives more than of cheese for each barrel of beer it exports to Italy. Based on your answer to the last question, which of the following prices of trade (that is, price of cheese in terms of beer) would allow both Germany and Italy to gain from trade? Check all that apply. 8 barrels of beer per pound of cheese 3 barrels of beer per pound of cheese 9 barrels of beer per pound of cheese 1 barrel of beer per pound of cheese

Answer 1

Step-by-step explanation:

Italy's opportunity cost of producing a pound of cheese is

= 5 barrels of beer

Germany's opportunity cost of producing a pound of cheese is

= 10 barrels of beer

Italy's opportunity cost of producing a barrel of beer is

=
`(1)/(5)`

= 0.2

Germany's opportunity cost of producing a barrel of beer is

=
`(1)/(10)`

= 0.1

A country is said to be having a comparative advantage in producing a good if it can produce it at a lower opportunity cost.

Here, Italy has a lower opportunity cost of producing cheese. So we can say that it has a comparative advantage in making cheese.

Germany has a lower opportunity cost in producing beer so it has a comparative advantage in making beer.

Italy gains from trade as long as it earns more than 5 barrels of beer for each pound of cheese, which is its opportunity cost, from trade.

Germany gains from trade as long as it gains more than 0.1 pounds of cheese for each barrel of beer.

Trade prices will be 8 barrels of beer per pound of cheese and 9 barrels of beer per pound of cheese. Since Italy will want more than 5 barrels of beer, the other two options will not be accepted.