Question

Suppose that Spain and Switzerland both produce beer and cheese. Spain's opportunity cost of producing a pound of cheese is 5 barrels of beer while Switzerland'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 (Spain/Switzerland) has a comparative advantage in the production of cheese and (Spain/Switzerland) has a comparative advantage in the production of beer.

Suppose that Spain and Switzerland consider trading cheese and beer with each other. Spain can gain from specialization and trade as long as it receives more than (1, 1/10, 1/5, 5, 10)  barrels   of beer for each pound of cheese it exports to Switzerland. Similarly, Switzerland can gain from trade as long as it receives more than(1, 1/10, 1/5, 5, 10) pound   of cheese for each barrel of beer it exports to Spain.

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 Switzerland and Spain to gain from trade? Check all that apply.

A. 6 barrels of beer per pound of cheese

B. 1 barrel of beer per pound of cheese

C. 7 barrels of beer per pound of cheese

D. 4 barrels of beer per pound of cheese

Answer 1

Spain has a comparative advantage in the production of cheese since it has to give up only 5 barrels of beer for producing one pound of cheese, whereas, Switzerland has to give up 10 barrels of beer which is higher.  Switzerland has a comparative advantage in the production of beer since it has to give up 1/10th pound of cheese, whereas, Spain has to give up 1/5th pound of cheese which is higher.

The price must be greater than the opportunity cost of the seller and less than the opportunity cost of the buyer. The terms of trade should lie between the opportunity cost of the buyer and seller to be beneficial to both.

More than 5 barrels.

More than 1/10th pound of cheese.

A and C.