Exhibit 34-1 Refer to Exhibit 34-1. Considering the data, which of the following terms of trade would both countries agree to?

Question

Exhibit 34-1  Refer to Exhibit 34-1. Considering the data, which of the following terms of trade would both countries agree to?

Quizplus · Accepted Answer

Country X has a comparative advantage in producing X, as it has a lower opportunity cost of producing X (2 units of Y) compared to Country Y (4 units of Y). 
Country Y has a comparative advantage in producing Y, as it has a lower opportunity cost of producing Y (0.25 units of X) compared to Country X (0.5 units of X).
To find the mutually beneficial terms of trade, we need to find a trade ratio between X and Y that lies between the opportunity costs of each country. 
The opportunity cost of producing 1 unit of X for Country Y is 0.25 units of Y. Therefore, Country Y should be willing to trade 1 unit of Y for more than 0.25 units of X to make a profit. 
The opportunity cost of producing 1 unit of Y for Country X is 2 units of X. Therefore, Country X should be willing to trade 1 unit of X for less than 2 units of Y to make a profit. 
The only trade ratio that lies between these opportunity costs is 1 unit of Y for 0.75 units of X. Therefore, both countries would agree to this terms of trade.