France and Denmark: Comparative Advantage and Trade Analysis
1. By comparing the opportunity cost of producing wine in the two countries, you can tell that _________ ( Denmark, France) has a comparative advantage in the production of wine and __________ (France, Denmark) has a comparative advantage in the production of oil.
Who has a comparative advantage in the production of wine? Who has a comparative advantage in the production of oil?
2. Suppose that France and Denmark consider trading wine and oil with each other. France can gain from specialization and trade as long as it receives more than _________ (1 barrel, 1/10 barrel, 1/5 barrel, 5 barrels, 10 barrels) of oil for each bottle of wine it exports to Denmark. Similarly, Denmark can gain from trade as long as it receives more than ________ (1 barrel, 1/10 barrel , 1/5 barrel, 5 barrel, 10 barrels) of wine for each barrel of oil it exports to France.
How much oil must France receive for each bottle of wine it exports to Denmark to gain from trade? And how much wine must Denmark receive for each barrel of oil it exports to France to gain from trade?
3. Based on your answer to the last question, which of the following terms of trade would allow both Denmark and France to gain from trade? Check all that apply.
Which terms of trade would benefit both Denmark and France in trading wine and oil with each other?
Answers:
1. Denmark has a comparative advantage in the production of oil, while France has a comparative advantage in the production of wine.
2. France gains 5 barrels of oil for each bottle of wine it exports to Denmark, while Denmark gains 10 barrels of wine for each barrel of oil it exports to France.
3. The answer is B: 2 barrels of oil per bottle of wine
Explanation:
1. The law of comparative cost advantage states that countries should specialize in the production of commodities in which they have a comparative advantage over the others. Each country tries to specialize in the production of those commodities in respect of which it has the greatest relative advantage over others. For France, the opportunity cost of producing wine over oil is 5 ÷ 10 = 1/2, for Denmark, the opportunity cost of producing oil over wine is 10 ÷ 5 = 2. Therefore, Denmark has a comparative advantage in the production of oil, while France has a comparative advantage in the production of wine.
2. The gain of specialization if the two countries consider trading wine and oil with each other is that France will gain 5 barrels of oil for each bottle of wine it exports to Denmark, while Denmark will gain 10 barrels of wine for each barrel of oil it exports to France. This indicates that both countries can benefit from specialization and trade.
3. The term of trade measures the amount of imports that are exchanged in return for exports. The term of trade is the price ratio between imports and exports. In this case, the term of trade is calculated as 10 ÷ 5 = 2. Therefore, both Denmark and France will gain from trade with a term of trade of 2 barrels of oil per bottle of wine.