If the international terms of trade settle at a level that is between each country’s opportunity cost

 Options:

a. There is no basis for gainful trade for either country b. Both countries gain from trad c. Only one country gains from trade d. One country gains and the other country loses from trade

The Correct Answer Is:

b. Both countries gain from trad

Correct Answer Explanation: b. Both countries gain from trad

When the international terms of trade settle at a level between each country’s opportunity cost, it means that the exchange ratio is mutually beneficial for both trading partners. In this scenario, both countries can trade goods at a rate that is better than their opportunity cost for producing those goods domestically. This situation leads to mutual gains from trade.

To illustrate this, let’s consider a hypothetical scenario with two countries, Country A and Country B. Country A can produce wheat and corn, and Country B can produce machinery and textiles. The opportunity cost is the amount of one good that must be sacrificed to produce an additional unit of another good.

Suppose that Country A can produce one unit of wheat by sacrificing the production of two units of corn, while Country B can produce one unit of machinery by sacrificing the production of three units of textiles. If the terms of trade are set at a ratio between 2:3 (two units of corn for three units of textiles), both countries will benefit.

Country A, by specializing in producing wheat and trading it for textiles, can obtain textiles at a better rate than if it were to produce them domestically. Similarly, Country B, by specializing in producing textiles and trading them for wheat, can obtain wheat at a more favorable rate than if it tried to produce it themselves. This situation results in both countries gaining from trade.

Now, let’s discuss why the other answer options are not correct:

a. There is no basis for gainful trade for either country:

This option assumes that the terms of trade are not advantageous for either country. However, in the scenario described, the terms of trade are set at a level between each country’s opportunity cost. This implies that both countries can benefit from trade.

The terms of trade provide a mutually beneficial exchange ratio, allowing both countries to obtain goods at a rate that is better than their domestic opportunity cost. Therefore, there is a clear basis for gainful trade for both countries in this situation.

c. Only one country gains from trade:

This option suggests that only one country benefits from trade, while the other does not. However, in the scenario provided, the terms of trade are set at a level between each country’s opportunity cost. This means that both countries can trade goods in a way that is more favorable than producing those goods domestically.

Both countries can obtain goods at a rate that is better than their opportunity cost, leading to gains for both. Therefore, both countries have the potential to benefit from trade in this situation.

d. One country gains and the other country loses from trade:

This option implies a zero-sum outcome, where one country benefits at the expense of the other. However, in the scenario described, the terms of trade are mutually beneficial. When the terms of trade settle at a level between each country’s opportunity cost, it indicates that both countries can gain from trade.

There is no inherent mechanism in this situation for one country to lose while the other gains. Instead, both countries have the opportunity to improve their economic welfare through trade.

In summary, the incorrect answer options (a, c, and d) are not applicable in the scenario where the international terms of trade settle at a level between each country’s opportunity cost. In this situation, both countries have the potential to benefit from trade, as the terms of trade provide a mutually advantageous exchange ratio.

This exemplifies the positive-sum nature of international trade, where both trading partners can improve their economic well-being through specialization and exchange.

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