Assume that by devoting all its resources to the production of X, nation Alpha can produce 20 units of X. By devoting all its resources to Y, Alpha can produce 30Y. Comparable figures for nation Beta are 60X and 40Y. Alpha would prefer terms of trade at, or close to, 1X = ²/₃Y.

Question

Quizplus · Accepted Answer

The preference for terms of trade depends on the relative opportunity costs of producing X and Y for each nation. In this case, Alpha's opportunity cost of producing one unit of Y is 2X (30Y/20X), while Beta's opportunity cost of producing one unit of Y is 1.5X (60X/40Y). Therefore, Alpha has a comparative advantage in producing X, while Beta has a comparative advantage in producing Y. The formula given in the question represents the terms of trade that would allow both nations to benefit from trade by exchanging goods at a rate that reflects their relative opportunity costs. As Alpha prefers terms of trade that allow it to obtain more units of Y for each unit of X, this implies that it values Y relatively more than X, which is consistent with its comparative disadvantage in producing Y.

Assume That by Devoting All Its Resources to the Production