If two countries voluntarily trade two goods with one another, the rate of exchange between the goods must fall in between the price ratios that would prevail in the two countries in the absence of trade.

Question

Quizplus · Accepted Answer

This is known as the principle of comparative advantage, which states that each country should specialize in producing and exporting the goods in which it has a lower opportunity cost of production and import the goods in which it has a higher opportunity cost of production. As a result, the terms of trade (the rate of exchange between the goods) will fall somewhere in between the price ratios that would prevail in the two countries in the absence of trade.

If Two Countries Voluntarily Trade Two Goods with One Another