Assume that two countries (Home and Foreign) each produce two goods
(corn and wheat) under constant cost production.Home produces 0.5
Ton of corn or a ton of wheat with a day of labor.Foreign produces a ton
Of corn and 0.5 ton of wheat.Without trade (in autarky), Home's daily
Production is 20 tons of wheat and 10 tons of corn.At which
International price will Home's gains from trade be largest?
A)0.5 ton of wheat per ton of corn
B)1 ton of wheat per ton of corn
C)1.5 tons of wheat per ton of corn
D)2 tons of wheat per ton of corn

Question

Quizplus · Accepted Answer

To determine the international price at which Home's gains from trade will be largest, we need to compare the domestic opportunity costs of producing each good with the opportunity costs of producing these goods in the foreign country.

Without trade, Home can produce 1 ton of wheat with 2 days of labor, or 0.5 tons of corn with 1 day of labor. The opportunity cost of producing 1 ton of wheat is therefore 2/0.5 = 4 tons of corn. Likewise, the opportunity cost of producing 1 ton of corn is 0.5/1 = 0.5 tons of wheat.

In Foreign, the opportunity cost of producing 1 ton of corn is 2 tons of wheat (since Foreign can produce 1 ton of corn by giving up the opportunity to produce 0.5 tons of wheat). The opportunity cost of producing 1 ton of wheat is 0.5 tons of corn (since Foreign can produce 1 ton of wheat by giving up the opportunity to produce 0.5 tons of corn).

Based on these opportunity costs, we can see that Foreign has a comparative advantage in producing corn, while Home has a comparative advantage in producing wheat. Therefore, Home will benefit from trading wheat for corn with Foreign.

To determine the best international price, we need to compare the domestic exchange ratio of the two goods with the exchange ratio that Foreign is willing to accept. If the international price is more advantageous for Home than the domestic exchange ratio, Home will benefit from trade.

The domestic exchange ratio for Home is 2 tons of wheat for 1 ton of corn (since the opportunity cost of producing 1 ton of corn for Home is 4 tons of wheat).

Foreign is willing to trade corn for wheat at a ratio of 1 ton of corn for 0.5 tons of wheat (since the opportunity cost of producing 1 ton of corn for Foreign is 2 tons of wheat).

Therefore, the international price must be more advantageous for Home than the domestic exchange ratio of 2 tons of wheat for 1 ton of corn, but less advantageous than Foreign's exchange ratio of 1 ton of corn for 0.5 tons of wheat. This means that the best international price for Home is the midpoint between the two ratios, which is 0.5 tons of wheat for 1 ton of corn.

Therefore, the answer is A: 0.5 ton of wheat per ton of corn.

Assume That Two Countries (Home and Foreign) Each Produce Two