Suppose that Portugal and Germany both produce oil and cheese. Portugal's opportunity cost of producing a pound of cheese is 3 barrels of oil while Germany's opportunity cost of producing a pound of cheese is 11 barrels of oil. By comparing the opportunity cost of producing cheese in the two countries, you can tell that has a comparative advantage in the production of cheese and has a comparative advantage in the production of oil.
Suppose that Portugal and Germany consider trading cheese and oil with each other. Portugal can gain from specialization and trade as long as it receives more than of oil for each pound of cheese it exports to Germany. Similarly, Germany can gain from trade as long as it receives more than of cheese 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 cheese in terms of oil) would allow both Germany and Portugal to gain from trade?
a. 7 barrels of oil per pound of cheese
b. 18 barrels of oil per pound of cheese
c. 2 barrels of oil per pound of cheese
d. 5 barrels of oil per pound of cheese

Portugal and Germany and Comparative Advantage

a. Portugal

b. Germany

c. 3 barrels of oil

d. 1/11 barrels of cheese

e. 4 (11/3) barrels of oil per pound of cheese.

Explanation:

a) Data and Calculations:

Portugal's opportunity cost of producing a pound of cheese = 3 barrels of oil

Germany's opportunity cost of producing a pound of cheese = 11 barrels of oil

3/11 = 0.27

b) Portugal enjoys comparative advantage in the production of cheese while Germany enjoys comparative advantage in the production of oil because Portugal can produce cheese at lower costs than Germany while Germany can produce oil more efficiently than Portugal.  When these two countries specialize in the production of the product that they enjoy comparative advantage, more goods will be produced in total, and they can exchange their surpluses with each other.

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