Suppose that France and Denmark both produce oil and olives. Frances’s opportunity cost of producing a crate of olives is 4 barrels of oil, while Denmark’s opportunity cost of producing a crate of olives is 7 barrels of oil.

Question

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 oil.

Suppose that France and Denmark consider trading olives and oil with each other. France can gain from specialization and trade as long as it receives more than _____ of oil for each crate of olives it exports to Denmark. Similarly, Denmark can gain from trade as long as it receives more than _____ of olives for each barrel of oil it exports to France.

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

__ 6 barrels of oil per crate of olives
__ 3 barrels of oil per crate of olives
__ 5 barrels of oil per crate of olives
__ 8 barrels of oil per crate of olives

Answer 1

France has a comparative advantage in the production of olives and Denmark has a comparative advantage in the production of oil. France can gain from specialization and trade as long as it receives more than 3 barrels of oil for each crate of olives it exports to Denmark. Similarly, Denmark can gain from trade as long as it receives more than 6 barrels of olives for each barrel of oil it exports to France.

Based on your answer to the last question, the following terms of trade would allow both Denmark and France to gain from trade: 3 barrels of oil per crate of olives, 5 barrels of oil per crate of olives, and 6 barrels of oil per crate of olives.