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CA Foundation · Business Economics · International Trade

Which of the following exchange ratios would make trade beneficial for both India and Nepal, if in India the opportunity cost of 1 kg of tea is 2 metres of cloth and in Nepal the opportunity cost of 1 kg of tea is 4 metres of cloth?

The ratio of 1 kg of tea for 3 metres of cloth benefits both. The terms of trade must lie strictly between the two domestic opportunity costs, 2 and 4 metres. Within this range, India gets more cloth than at home and Nepal pays less.

  1. A1 kg of tea for 1.5 metres of cloth
  2. B1 kg of tea for 3 metres of clothCorrect
  3. C1 kg of tea for 5 metres of cloth
  4. D1 kg of tea for 2 metres of cloth

Explanation

India has the lower cost of tea (2 cloth) and Nepal the higher (4 cloth). India exports tea and gains if it receives more than 2 metres of cloth per kg; Nepal gains if it pays less than 4. So the ratio must lie strictly between 2 and 4, and only 3 qualifies. 1.5 is below India's own cost and 5 is above Nepal's own cost, so one country would lose; 2 gives India no gain.

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