Question

Consider Iran and Iraq and their production of oil and olive oil. Relatively recent OPEC estimates indicate that in July 2012, Iran produced about 4.1 million barrels of oil per day and Iraq produced about 3.2 million barrels of oil per day, making them the second- and third-largest oil producers in OPEC, behind Saudi Arabia (and the 4^th and 7^th largest oil producing countries in the world).  Suppose that Iran and Iraq both produce barrels of oil and bottles of olive oil, which are sold for the same price in both countries. These are the combinations of the two goods that each country can produce in one day using the same amounts of capital and labor (with all measures in millions throughout):

Iran		Iraq
Oil (Barrels)	Olive Oil (Bottles)	Oil (Barrels)	Olive Oil (Bottles)
0	12	0	8
2	9	2	6
4	6	4	4
6	3	6	2
8	0	8	0

Suppose that without specialization, Iran produces 4 barrels of oil and 6 bottles of olive oil, and Iraq produces 4 barrels of oil and 4 bottles of olive oil (in millions per day).  Are the countries better off or worse off with specialization and trade? Suppose that the terms of trade with specialization are 4 barrels of oil for 4.8 bottles of olive oil, and that 4 barrels of oil are indeed traded for 4.8 bottles of olive oil.  With specialization and trade, how many additional barrels of olive oil can Iraq consume?   Provide your answer as a number measured in millions rounded to two decimal places. Use "-" to indicate negative amounts. Do not include any symbols, such as "$," "=," "%," or "," in your answer.

Answer 1

The opportunity cost of 1 barrel of oil is 3/2 = 1.5 bottles of olive oil in Iran and 2/2 = 1 bottle of olive oil in Iraq. This implies that Iraq has comparative advantage in production of oil and Iran has comparative advantage in production of olive oil.

Without trade, Iraq consumes 4 bottles of olive oil and 4 barrels of oil. Currently 4 barrels of oil are traded against 4.8 bottles of olive oil. Iran produces and exports olive oil and Iraq produces and exports oil. Since Iran gets 4 barrels of oil when it exports 4.8 bottles of olive oil to Iran, it is left with 7 bottles of olive oil so it saves or gets an additional 0.8 bottles of olive oil.

The answer is 0.8 million bottles