Suppose that Dwight and Jim can either make salads or grill steaks. Their maximum output per hour is listed in the following table. Given the same quantity of resources, at what terms of trade (relative price ratio) could they specialize and trade so that both consume outside their own production possibilities frontier (PPF)?
A) 1 salad per 1 steak
B) 2 salads per 1 steak
C) 2.5 salads per 1 steak
D) 3 salads per 1 steak
E) 3.5 salads per 1 steak

Question

Suppose that Dwight and Jim can either make salads or grill steaks. Their maximum output per hour is listed in the following table. Given the same quantity of resources, at what terms of trade (relative price ratio) could they specialize and trade so that both consume outside their own production possibilities frontier (PPF)? 
A) 1 salad per 1 steak 
B) 2 salads per 1 steak 
C) 2.5 salads per 1 steak 
D) 3 salads per 1 steak 
E) 3.5 salads per 1 steak

Quizplus · Accepted Answer

To determine the terms of trade, we need to identify the opportunity cost of producing one salad versus one steak for each person. Dwight's opportunity cost of producing one salad is 1/2 steak, while Jim's opportunity cost of producing one salad is 1 steak. Therefore, Jim has a comparative advantage in producing steak and Dwight has a comparative advantage in producing salad. In order for both to consume outside their respective PPFs, they should specialize in producing the good that they have a comparative advantage in and trade with each other. The terms of trade should fall between their opportunity costs, which are 2.5 salads per steak for Dwight and 1 steak per 2.5 salads for Jim. Thus, the terms of trade should be 2.5 salads per 1 steak.

Suppose That Dwight and Jim Can Either Make Salads or Grill