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Suppose that France and Switzerland both produce beer and wine
Suppose that France and Switzerland both produce beer and wine. France's opportunity cost of producing a bottle of wine is 5 barrels of beer while Switzerland's opportunity cost of producing a bottle of wine is 10 barrels of beer. Which country has a comparative advantage in the production of wine? Which country has a comparative advantage in the production of beer? What terms of trade would allow both countries to benefit from trading?
Expert Solution
France has to give up less barrels of beer to produce a bottle of wine than Switzerland, so it has the comparative advantage in beer production. We can invert each country's opportunity cost of wine to get its opportunity cost of beer. If 1 bottle of wine costs 5 barrels of beer in France, then 1 barrel of beer is equal to 0.2 bottles of wine in France: 1/5 = 0.2.
If 1 bottle of wine costs 10 barrels of beer in Switzerland, then 1 barrel of beer is equal to 0.1 bottles of wine: 1/10 = 0.1. Switzerland has the lower opportunity cost of producing beer, so it has the comparative advantage in beer production.
Both countries will benefit from trade as long as the terms of trade are between the two countries' opportunity costs. For instance, if France traded one bottle of wine for an amount somewhere between 5-10 barrels of beer, both countries would be better off.
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