Counties A and B currently consume 400 units of food and 400 units of textiles each and currently do not trade with one another.The citizens of country A have to give up one unit of food to gain two units of textiles,while the citizens of country B have to give up one unit of textiles to gain two units of food.Their production possibilities curves are shown. Under the theory of comparative advantage,if free trade is allowed,the market clearing price (or exchange rate if you will)between food and textiles will be
A)one unit of food for one unit of textiles.
B)somewhere between one unit of food for two units of textiles and two units of food for one unit of textiles.
C)one unit of food for two units of textiles.
D)two units of food for one unit of textiles.

Question

Counties A and B currently consume 400 units of food and 400 units of textiles each and currently do not trade with one another.The citizens of country A have to give up one unit of food to gain two units of textiles,while the citizens of country B have to give up one unit of textiles to gain two units of food.Their production possibilities curves are shown.  Under the theory of comparative advantage,if free trade is allowed,the market clearing price (or exchange rate if you will)between food and textiles will be
A)one unit of food for one unit of textiles. 
B)somewhere between one unit of food for two units of textiles and two units of food for one unit of textiles. 
C)one unit of food for two units of textiles. 
D)two units of food for one unit of textiles.

Quizplus · Accepted Answer

Free trade would allow both countries to specialize in producing the good in which they have a comparative advantage. For country A, this would be textiles since they have a lower opportunity cost of producing textiles compared to country B. For country B, this would be food since they have a lower opportunity cost of producing food compared to country A. 
The market-clearing price would fall between the opportunity cost of each country. For country A, the opportunity cost of producing one unit of textiles is one unit of food, while for country B, the opportunity cost of producing one unit of food is one unit of textiles. Therefore, the exchange rate would fall somewhere between one unit of food for two units of textiles (country A's opportunity cost) and two units of food for one unit of textiles (country B's opportunity cost).

Counties a and B Currently Consume 400 Units of Food