Question

3. 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

What is the opportunity cost of producing one barrel of oil (in terms of a bottle of olive oil) for Iran and for Iraq?

Which country has a comparative advantage producing oil and which country has a comparative advantage producing olive oil?

Suppose that Iran is currently producing 4 barrels of oil and 6 bottles of olive oil, and Iraq is currently producing 4 barrels of oil and 4 bottles of olive oil (in millions per day).

If Iran and Iraq each specialize in producing only one good (the good for which each has a comparative advantage), then how many additional barrels of oil can be produced for the two countries combined? How many additional olive oil bottles can be produced for the two countries combined? Answer this question by filling in the table below.

Production with Trade
	Oil (Barrels)	Olive Oil (Bottles)
Iran
Iraq

Now suppose the terms of trade are 4 barrels of oil for 5 bottles of olive oil, and that 4 barrels of oil are indeed traded for 5 bottles of olive oil.

How much can each country consume with trade? Answer this question by filling in the table below.

Consumption with Trade
	Oil (Barrels)	Olive Oil (Bottles)
Iran
Iraq

Are the countries better off or worse off with trade? Answer this question by filling in the table below.

Gains from Trade
	Oil (Barrels)	Olive Oil (Bottles)
Iran
Iraq

Answer 1

the opportunity cost of producing one barrel of oil for Iran = 12/8 = 1.5 bottles of olive oil

the opportunity cost of producing one barrel of oil for Iraq = 8/8 = 1 bottle of olive oil

Iraq has a comparative advantage producing oil (lower opportunity cost) and Iran has a comparative advantage producing olive oil.

Production with Trade
	Oil (Barrels)	Olive Oil (Bottles)
Iran	0	12
Iraq	8	0

Additional barrels of oil = 8 - (4 + 4) = 0

Additional bottles of olive oil = 12 - (4 + 6) = 2

Consumption with Trade
	Oil (Barrels)	Olive Oil (Bottles)
Iran	4	7
Iraq	4	5

Gains from Trade
	Oil (Barrels)	Olive Oil (Bottles)
Iran	0	1
Iraq	0	1

Change in consumption = Gains from trade