Question

The price of trade Suppose that Italy and Denmark both produce oil and olives. Italy'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 10 barrels of oil. 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 Italy and Denmark consider trading olives and oil with each other. Italy 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 Italy. Based on your answer to the last question, which of the following prices of trade (that is, price of olives in terms of oil) would allow both Denmark and Italy to gain from trade? Check all that apply. 16 barrels of oil per crate of olives 2 barrels of oil per crate of olives 7 barrels of oil per crate of olives 9 barrels of oil per crate of olives

Answer 1

Consider the given problem here there are 2 countries “Italy” and “Denmark” and 2 goods “oil” and “olives”. Now Italy'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 10 barrels of oil. So, we can see that “Italy” have comparative advantage of producing “olives” while “Denmark” have comparative advantage in producing “oil”. Since "Italy" have lower oppertunity cost of producing "olives" and "Denmark" have lower oppertunity cost of producing "oil".  

Now, if they trade to each other then both of them will gain from trade only if the relative price of “olives” is between the opportunity cost of both countries. So, here the opportunity cost of producing olives is “4” of “Italy” and “10” of “Denmark”. So, the relative price of “olives” should be between “4” and “10”. So, if the “p” be the relative price of olives, => it must be “4 < p < 10”. If “p < 4, 10”, => both country will specialize to “oil” on the other hand if “p > 4, 10”, => both country will specialize to “olives”, => in both these possibilities trade will not possible.

So, “p” must be between “4” and “10”. So, here there are 2 possibility these are “7” and “9”, => “C” and “D” are correct answer.