Question

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? 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?

Answer 1

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

Step-by-step 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.

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.

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