Suppose that Spain has a comparative advantage in hats and Portugal has a comparative advantage in doormats. Under a system of free trade, each country specialises and then trades with the other. If the price starts at four hats per doormat, and then increases to five hats per doormat, then:

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Quizplus · Accepted Answer

The increase in the price of hats relative to doormats indicates that there is a higher demand for hats in the market. This suggests that Spain's comparative advantage in hats is still present but the gains from trade have shifted to Portugal, as they are now able to sell their doormats at a higher price. Therefore, option D is correct: some of the gains from trade shift to Portugal. Option A is incorrect because an increase in the price of hats relative to doormats does not necessarily mean people in Portugal will not want to buy as many hats. Option B is incorrect because an increase in the price of hats relative to doormats does not change Spain's comparative advantage in hats. Option C is incorrect because an increase in the price of hats relative to doormats does not imply that Portugal is flooding the market with too many doormats.

Suppose That Spain Has a Comparative Advantage in Hats and Portugal