Benefits of Specialization and Trade Between Iran and Iraq

Specialization and Trade Scenario:

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?

Terms of Trade:

Suppose that the terms of trade with specialization are 4 barrels of oil for 4.3 bottles of olive oil, and that 4 barrels of oil are indeed traded for 4.3 bottles of olive oil. With specialization and trade, how many additional barrels of olive oil can Iran consume?

Question:

With specialization and trade, how many additional barrels of olive oil can Iran consume?

Answer:

With specialization Iran will be able to consume 1.7 bottles of olive oil.

Explanation:

Iran produces 4 barrels of oil and 6 bottles of olive oil. Iraq produces 4 barrels of oil and 4 bottles of olive oil.

The opportunity cost of producing a barrel of oil for Iran = 6/4 = 1.5

The opportunity cost of producing a barrel of oil for Iraq = 4/4 = 1

Iraq has a lower opportunity cost for producing oil, so we can say it has a comparative advantage in producing oil.

The opportunity cost of producing a barrel of olive oil for Iran = 4/6 = 0.66

The opportunity cost of producing a barrel of olive oil for Iraq = 4/4 = 1

Iran has a lower opportunity cost for producing olive oil, so we can say it has a comparative advantage in producing it.

Without trade, Iran is consuming 4 barrels of oil and 6 bottles of olive oil.

With specialization, Iran will be able to consume = 6 - 4.3 = 1.7 bottles of olive oil.