The domestic cost ratios of nations set the outer limits to the equilibrium terms of trade.

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The production possibilities frontier shows the maximum amount of goods that a country can produce with its limited resources. The domestic cost ratios, which refer to the opportunity cost of producing one good in terms of another, determine the relative prices of goods and services in the economy. The terms of trade, or the ratio of export prices to import prices, will tend to settle between the opportunity costs of the two trading partners. Therefore, the domestic cost ratios set the outer limits to the equilibrium terms of trade.

The Domestic Cost Ratios of Nations Set the Outer Limits