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Homework answers / question archive / Suppose that Portugal and Austria both produce oil and olives
Suppose that Portugal and Austria both produce oil and olives. Portugal's opportunity cost of producing a crate of olives is 4 barrels of oil while Austria's opportunity cost of producing a crate of olives is 10 barrels of oil.
By comparing the opportunity cost of producing olives in the two countries, you can tell that ? has a comparative advantage in the production of olives and ? has a comparative advantage in the production of oil.
Supposed that Portugal and Austria consider trading olives and oil with each other. Portugal can gain from specialization and trade as long as it receives more than ? of oil for each crate of olives it exports to Austria. Similarly, Austria can gain from trade as long as it receives more than ? of olives for each barrel of oil it exports to Portugal. Based on your answer to the last question, which of the following terms of trade (that is, price of olives in terms of oil) would allow both Austria and Portugal to gain from trade? Check all that apply.
a. 6 barrels of oil per crate of olives
b. 3 barrels of oil per crate of olives
c. 1 barrel of oil per crate of olives
d. 18 barrels of oil per crate of olives
Portugal has a lower opportunity cost of producing olives so Portugal has a comparative advantage in olives and Austria has a comparative advantage in oil. Portugal can gain from trade and specialization as long as it receives more than 4 barrels of oil for each crate of olives it exports. Austria can gain from trade and specialization as long as it receives more than 1/10 crates of olives for each barrel of oil it exports. Austria and Portugal gain from trade if the terms of trade are 18 barrels of oil per crate of olives.
