Answer: Current level of Production of Spain is 6 million tons of grapes and 0.6 million tons of lemons. For Argentina it is 3 million tons of Grapes and 1 million tons of lemon.
If Spain uses all its resources in the production of one good, then it can produce at most 12 million tons of grapes or 1.2 million tons of lemons.
Similarly, if Argentina uses all its resources in the production of one good then it can produce at most 5.5 million tons of Grapes or 2.2 million tons of lemons.
Comparing the quantities of Spain and Argentina we can say that Spain has an absolute as well as comparative advantage in the production of Grapes and Argentina in the production of lemons.
So, when the two countries trade it is wise for Spain to produce only Grapes and Argentina to produce only Lemons.
Terms of trade is given as,
1 million tons of Grapes = 0.2 million tons of Lemons
So, if 4 million tons of grapes are exported from Spain to Argentina, Spain will have in return,
4 million tons of grapes = 0.8 million tons of Lemons (hint: 0.2*4=0.8)
After trade their bundle of goods will include,
Spain will have 8 million tons of Grapes and 0.8 million tons of Lemons.
Argentina will have 4 million tons of Grapes and 1.4 million tons of Lemons.
Both of these bundles will lie to the right of the PPF. Therefore, we can say that both the countries gain from trade.
