Assume the Italy and Spain both produce lumber and vehicles at a constant opport

Question

Assume the Italy and Spain both produce lumber and vehicles at a constant opportunity cost. Using its resources efficiently, Italy can produce either 100 tons of lumber and no vehicles or 10,000 vehicles and no lumber, or any combination in-between. Using its resources efficiently, Spain can produce either 80 tons of lumber and no vehicles or 4,000 vehicles and no lumber, or any combination in-between.

a) Explain whether the Italy and Spain will benefit from trade. If the countries will benefit from trade, explain which country will produce lumber and which country will produce vehicles. Illustrate your answer with numbers.

Explanation / Answer

Italy can produce either 100 tons of lumber and no vehicles or 10,000 vehicles and no lumber

So the opportunity cost for Italy to produce Lumber:-

1 ton of Lumber = 10000 vehicles /100 = 100 vehicles

So the opportunity cost for Italy to produce vehicles:-

1 vehicle =100/10,000=0.01 ton of lumber

For Spain can produce either 80 tons of lumber and no vehicles or 4,000 vehicles

So the opportunity cost for Spain to produce Lumber:-

1 ton of Lumber = 4000 vehicles /80 = 50 vehicles

So the opportunity cost for Spain to produce vehicles:-

1 vehicle =80/4,000=0.00025 ton of lumber

If we look above, Spain has the absolute advantage in producing both lumber and vehicles in comparison to Italy as it has a lower opportunity cost for both lumber and vehicles. Thus the trade is not efficient.

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