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CA Foundation · Business Economics · International Trade

Using the data of India (1 kg rice = 2 m cloth) and Bangladesh (1 kg rice = 3 m cloth) in opportunity cost terms, at which exchange ratio would both countries gain from trade?

The ratio 1 kg rice = 2.5 m cloth lets both countries gain. Mutually beneficial terms of trade must fall strictly between the two domestic opportunity costs, here 2 and 3 metres of cloth per kg of rice. Ratios outside this range, or equal to an endpoint, leave one country no better off.

  1. A1 kg rice = 1.5 m cloth
  2. B1 kg rice = 2 m cloth
  3. C1 kg rice = 2.5 m clothCorrect
  4. D1 kg rice = 3.5 m cloth

Explanation

Mutually beneficial terms of trade must lie strictly between the two domestic opportunity costs, i.e. between 2 and 3 m cloth per kg of rice. 2.5 lies in that range. At 2 India gains nothing, and at 1.5 or 3.5 one country would be worse off than at home than without trade.

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