Question

Suppose that Italy and Switzerland both produce rye and wine. Italy's opportunity cost of producing a bottle of wine is 5 bushels of rye while Switzerland's opportunity cost of producing a bottle of wine is 10 bushels of rye.By comparing the opportunity cost of producing wine in the two countries, you can tell that, ITALY or SWITZERLAND, has a comparitive advantage in the production of wine and, ITALY or SWITZERLAND, has a comparative advantage in the production of rye.Suppose that Italy and Switzerland consider trading wine and rye with each other. Italy can gain from specialization and trade as long as it receives more than1 bushel1/10 bushel1/5 bushel5 bushels10 bushelsof rye for each bottle of wine it exports to Switzerland. Similarly, Switzerland can gain from trade as long as it receives more than1 bottle1/10 bottle1/5 bottle5 bottles10 bottlesof wine for each bushel of rye it exports to Italy.Based on your answer to the last question, which of the following terms of trade (that is, price of wine in terms of rye) would allow both Switzerland and Italy to gain from trade? Check all that apply.12 bushels of rye per bottle of wine1 bushel of rye per bottle of wine2 bushels of rye per bottle of wine6 bushels of rye per bottle of wine

Answer 1

Answer:

Italy has a comparative advantage in the production of wine.

Switzerland has a comparative advantage in the production of rye.

Italy can gain from trade as long as it receives more than 5 bushels of rye for each bottle of wine.

Switzerland can gain from trade as long as it receives more than 0.1 or 1/10 bottle of wine.

Trade price will be 6 bushels of rye per bottle of wine.

Explanation:

Italy and Switzerland both produce rye and wine.

Italy's opportunity cost of producing a bottle of wine

= 5 bushels of rye

Switzerland's opportunity cost of producing a bottle of wine

= 10 bushels of rye

Italy has a comparative advantage in the production of wine as it has lower opportunity cost.

Italy's opportunity cost of producing a bushel of rye

= $\frac{1}{5}$

= 0.2 bottle of wine

Switzerland's opportunity cost of producing a bushel of rye

= $\frac{1}{10}$

= 0.1 bottle of wine

Switzerland has a comparative advantage in the production of rye as it has lower opportunity cost.

Italy can gain from trade as long as it receives more than 5 bushels of rye for each bottle of wine. Switzerland can gain from trade as long as it receives more than 0.1 or 1/10 bottle of wine.

Both the countries will gain from trade if the trade price lies between their opportunity cost. So trade price in this situation will be 6 bushels of rye per bottle of wine.