Question

Suppose that Spain and Denmark both produce rye and shoes. Spain's opportunity cost of producing a pair of shoes is 3 bushels of rye while Denmark's opportunity cost of producing a pair of shoes is 10 bushels of rye. By comparing the opportunity cost of producing shoes in the two countries, you can tell that has a comparative advantage in the production of shoes and has a comparative advantage in the production of rye. Suppose that Spain and Denmark consider trading shoes and rye with each other. Spain can gain from specialization and trade as long as it receives more than of rye for each pair of shoes it exports to Denmark. Similarly, Denmark can gain from trade as long as it receives more than of shoes for each bushel of rye it exports to Spain. Based on your answer to the last question, which of the following prices of trade (that is, price of shoes in terms of rye) would allow both Denmark and Spain to gain from trade? Check all that apply.

7 bushels of rye per pair of shoes

1 bushel of rye per pair of shoes

4 bushels of rye per pair of shoes

18 bushels of rye per pair of shoes

Answer 1

a) By comparing the opportunity cost we can say that Spain has a comparative advantage in the production of shoe and Denmark has a comparative advantage in the production of Rye.

b) Spain can gain from trade as long as they are receiving more than 3 rye for a production of shoe and Denmark can gain from trade as long as they are getting more than 1/10 of a shoe for a Rye.

c) The trade should be more than 3 but less than 10 Rye for a shoe. The answer is A and C.