Suppose that a worker in Country A can produce either 25 bananas or 5 tomatoes each year. Country A has 200 workers. Suppose a worker in Country B can produce either 18 bananas or 6 tomatoes each year. Country B has 400 workers. Country B specializes in producing tomatoes and Country A specializes in producing bananas. What terms of trade would both countries be willing to agree to?
A) One tomato for one banana
B) One tomato for two bananas
C) One tomato for four bananas
D) One tomato for six bananas

Question

Quizplus · Accepted Answer

In Country A, one worker can produce 25 bananas or 5 tomatoes, which means that one banana costs 1/5 of a tomato in terms of opportunity cost. In Country B, one worker can produce 18 bananas or 6 tomatoes, which means that one banana costs 1/3 of a tomato in terms of opportunity cost. Therefore, Country A has a comparative advantage in producing bananas and Country B has a comparative advantage in producing tomatoes.

To determine the terms of trade that both countries would be willing to agree to, we need to find a price at which both countries would benefit from trade. If Country A were to trade one banana for less than 1/5 of a tomato, they would be better off producing tomatoes instead. Similarly, if Country B were to trade one tomato for less than 1/3 of a banana, they would be better off producing bananas instead.

The terms of trade that both countries would be willing to agree to lie somewhere between 1/5 and 1/3. Choice C, one tomato for four bananas, falls within this range and would be a mutually beneficial exchange for both countries.

Suppose That a Worker in Country a Can Produce Either