Suppose that Portugal and Austria both produce oil and shoes. Portugal's opportunity cost of producing a pair of shoes is 4 barrels of oil while Austria's opportunity cost of producing a pair of shoes is 10 barrels of oil. By comparing the opportunity cost of producing shoes in the two countries, you can tell that has a comparative advantage in the production of shoes and has a comparative advantage in the production of oil. Suppose that Portugal and Austria consider trading shoes and oil with each other. Portugal can gain from specialization and trade as long as it receives more than of oil for each pair of shoes it exports to Austria. Similarly, Austria can gain from trade as long as it receives more than of shoes for each barrel of oil it exports to Portugal. Based on your answer to the last question, which of the following prices of trade (that is, price of shoes in terms of oil) would allow both Sweden and Portugal to gain from trade?
a. 1 barrel of oil per pair of shoes
b. 9 barrels of oil per pair of shoes
c. 3 barrels of oil per pair of shoes
d. 8 barrels of oil per pair of shoes

1. By comparing the opportunity cost of producing shoes in the two countries, you can tell that Portugal has a comparative advantage in the production of shoes and Austria has a comparative advantage in the production of oil.

Portugal has a lower opportunity cost of 4 barrels of oil when producing a pair of shoes so it has a Comparative Advantage there.

Austria on the other hand produces more oil per shoe than Portugal so it has comparative advantage in Oil production.

2. Portugal can gain from specialization and trade as long as it receives more than 4 barrels of oil for each pair of shoes it exports to Austria. Similarly, Austria can gain from trade as long as it receives more than 0.1 pairs of shoes for each barrel of oil it exports to Portugal.

If Portugal was not engaging in trade, it would be able to make 4 barrels of oil if it was not making a shoe. A gain for them therefore would be more than 4 barrels of oil for one shoe because it would be higher than the opportunity cost of 4 barrels per shoe.

The same logic applies to Austria, they need to get more shoes than they would have made if they gave up oil. They would have made 1/10 = 0.1 pairs of shoes if they gave up 1 barrel of oil so if they receive more than 0.1 pairs of shoes for the same 1 barrels then they would have made a gain.

3. b. 9 barrels of oil per pair of shoes

d. 8 barrels of oil per pair of shoes

Both of these would be favorable as they would benefit both parties.

Portugal would get more barrels than they can produce per shoe and Austria would get more shoes than they can produce per barrel of oil.

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