CA Foundation · Business Economics · International Trade
Which of the following statements about the limits of the terms of trade between two trading countries is correct according to the comparative cost theory?
Mutually beneficial terms of trade lie between the two countries' domestic opportunity cost ratios. A country would refuse any ratio worse than its own domestic one, so the trade price must fall within that range for both nations to gain.
- AThey lie between the domestic opportunity cost ratios of the two countriesCorrect
- BThey must equal the domestic cost ratio of the larger country
- CThey must be lower than both domestic cost ratios
- DThey can be set anywhere, even outside the domestic cost ratios, with both countries still gaining
Explanation
Neither country would trade at a ratio worse than its own domestic opportunity cost ratio. Hence mutually beneficial terms of trade lie between the two domestic ratios. Where exactly they settle depends on relative demand and bargaining strength in each country.
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