Question

Suppose that Italy and Austria both produce fish and cheese. Italy's opportunity cost of producing a pound of cheese is 4 pounds of fish while Austria's opportunity cost of producing a pound of cheese is 10 pounds of fish. By comparing the opportunity cost of producing cheese in the two countries, you can tell thatItaly has a comparative advantage in the production of cheese andAustria has a comparative advantage in the production of fish. Suppose that Italy and Austria consider trading cheese and fish with each other. Italy can gain from specialization and trade as long as it receives more than of fish for each pound of cheese it exports to Austria. Similarly, Austria can gain from trade as long as it receives more than of cheese for each pound of fish it exports to Italy. Based on your answer to the last question, which of the following prices of trade (that is, price of cheese in terms of fish) would allow both Austria and Italy to gain from trade? Check all that apply. 9 pounds of fish per pound of cheese 18 pounds of fish per pound of cheese 3 pounds of fish per pound of cheese 1 pound of fish per pound of cheese

Answer 1

Explanation:

Italy's opportunity cost of producing a pound of cheese is

= 4 pounds of fish

Austria's opportunity cost of producing a pound of cheese is

= 10 pounds of fish

Italy's opportunity cost of producing a pound of fish is

= $\frac{1}{4}$

= 0.25 pounds of cheese

Austria's opportunity cost of producing a pound of fish is

= $\frac{1}{10}$

= 0.1 pounds of cheese

A country is considered to have a comparative advantage in the production of a commodity if it has a relatively lower opportunity cost of production.

Here, Italy has a lower opportunity cost of producing cheese, so it has a comparative advantage in producing cheese.

Similarly, Austria has a lower opportunity cost of producing fish, so it has a comparative advantage in producing fish.

Italy can gain from trade as long as it is getting more than 4 pounds of fish for a pound of cheese.

Austria can gain from trade if it is getting more than 0.1 pounds of cheese for each pound of fish.

Both the countries will gain from the trade if the price of the trade is 9 pounds of fish per pound of cheese.

Italy will not accept 3 pounds of fish per pound of cheese and 1 pound of fish per pound of cheese as it is not covering the opportunity cost.

Austria will not pay 18 pounds of fish per pound of cheese.