Principles of Microeconomics / Unit 16 MIC 1507 worked example, 60 to 90 seconds
The Terms of Trade and the Gain
The idea
Any trading ratio strictly between the two countries' opportunity costs leaves both better off, since each gets the other good cheaper than by making it. Pick a ratio in that range, let each country specialize, choose an exchange, and show that each ends up with more of at least one good and no less of the other: a consumption point outside its frontier. Then add world output before and after.
In practice
Worked example: Northland's bolt costs two tons and Southland's one, so any ratio between one and two tons per bolt works; take one and a half. Northland, one hundred workers, made four hundred tons and two hundred bolts; it now makes eight hundred tons, sends three hundred for two hundred bolts, and keeps five hundred tons and two hundred bolts. Southland, three hundred workers, made three hundred tons and three hundred bolts; it now makes six hundred bolts, sends two hundred for three hundred tons, and keeps three hundred tons and four hundred bolts. World wheat rose from seven hundred to eight hundred and cloth from five hundred to six hundred.
Where people slip
A ratio outside the range makes one country worse off than self-sufficiency, and it refuses; the range, not the exact ratio, is the theory's result. And the split of the gain depends on where in the range the ratio lands, which demand and supply decide.
Your place on the trail
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