Karl can produce either 10 tons of oranges or 5 tons of apples in a year, while Adam can produce either 5 tons of oranges or 10 tons of apples in a year. Which of the following terms of trade would allow both Karl and Adam to gain from specialization and trade?

Question

Quizplus · Accepted Answer

To find the terms of trade that benefit both Karl and Adam, we need to look for a rate at which both Karl and Adam value their goods the same. That rate is the opportunity cost of producing one good in terms of the other.

For Karl, the opportunity cost of producing one ton of oranges is 1/2 ton of apples (10 tons of oranges / 5 tons of apples). 
For Adam, the opportunity cost of producing one ton of oranges is 2 tons of apples (5 tons of oranges / 10 tons of apples).

To benefit from trade, the terms of trade should lie between the opportunity costs of both producers. 
Therefore, the best choice is B, where the terms of trade are 1 ton of apples for 1.5 tons of oranges. 
Both Karl and Adam value oranges at 1/2 ton of apples and 2/3 ton of apples respectively, while the terms of trade is 1 apple for 1.5 oranges. 
Therefore, both producers will gain from trade, as they can specialize in producing the good that they are most efficient at and trade for the other one.

Karl Can Produce Either 10 Tons of Oranges or 5