Assume the following table shows the yields per acre of wine grapes and olive oi

Question

Assume the following table shows the yields per acre of wine grapes and olive oil in two different countries. Country A and country Z. (Also assume that in each country the labor and other processing costs per acre are the same regardless of whether grape vines or olive trees are cultivated). Suppose initially each country had erected high tariff barriers to keep out foreign wine and/or olive oil and was producing for its own needs only. Could consumers in both countries benefit if all trade barriers were dropped? If not, explain why not. If consumers could benefit, explain how and identify: a) which country has the greater opportunity cost of producing olive oil b)the country which would end up exporting wine and which would export olive oil after the elimination of trade barriers.

Explanation / Answer

For country A

the opportunity cost of 1 barrel of olive oil yeild = 2.25 Grape yeild (90/40).

the opportunity cost of 1 Grape yeild = 0.44 barrel of olive oil yeild (40/90).

For country B

the opportunity cost of 1 barrel of olive oil yeild = 1.5 Grape yeild (45/30).

the opportunity cost of 1 Grape yeild = 0.66 barrel of olive oil yeild (30/45).

A)

Country A has greater opprtunity cost of producing olive oil. (2.25>1.5)

B)

After elimination of trade barriers both countries will specialize in production of goods of their comparative advantage (i.e lesser opprtunity cost). So Country A will produce and export Wine and Country Z will specialize in production and export of olive oil.

Therefore, both the countries can gain by trading olive oil for grape yeild.

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