Question

The output produced by Samuel and Roberto in 20 hours is given below for wine and cheese.

	wine	Cheese
Samuel	6	4
roberto	2	3

1. Who has comparative advantage in what commodity?
2. How much would they exchange and at what price? Show all calculations.

Please help me with what terms of trade mean

Answer 1

A) In 20 hours, Samuel can produce either 6 wine or 4 cheese. Therefore, Samuel's opportunity cost of producing 1 wine is (4/6) = (2/3) cheese and o.c of producing 1 cheese is (6/4) = 1.5 wine.

In 20 hours, Roberto can produce either 2 wine or 3 cheese. Therefore, Roberto's o.c of producing 1 wine is (3/2) = 1.5 cheese and o.c of producing 1 cheese is (2/3) wine.

As, Roberto's o.c of producing 1 cheese is less than Samuel's opportunity cost of producing 1 cheese, therefore, Roberto has comparative advantage in production of the cheese. But, Samuel has comparative advantage in production of the wine because his opportunity cost of producing 1 wine is less than that of Roberto's.

B) If they specialize in the production in which they have comparative advantage, then Roberto will specialize in cheese production and Samuel will specialize in wine production. Both of them will benefit from trade only if the terms of trade (relative price of import in terms of export is known as Terms of trade, and here will calculate the TOT in terms of cheese for each unit of wine traded) lies between both countries' opportunity cost of producing cheese. So, the TOT will be between (2/3) and 1.5 cheese for 1 unit of wine traded.