As a general rule, the terms of international trade between two countries falls between the opportunity cost of production in each of the countries, with adjustment for any transportation or shipping cost.

The Opportunity Cost of Production

Two Countries, Two Goods

Both nations are able to produce two goods -- turnips and sundials. In the United Provinces of Csonda, one worker over a one month period is able to produce 60 pounds of turnips or 20 sundials. In contrast, in the Republic of Northwest Queoldiola, one worker over a period of one month is able to produce 20 pounds or turnips or 10 sundials.

Consider the cost of sundial production in the two countries.

• If Csonda switches a unit of labor from turnip production to sundial production, it is able to produce 20 sundials and in so doing gives up 60 pounds of turnips. As such, the production of each Csondan sundial incurs an opportunity cost of 3 pounds of turnips.


• In contrast, if Northwest Queoldiola switches a unit of labor from turnip production to sundial production, it is able to produce 10 sundials, but in so doing only gives up 20 pounds of turnips. As such, the production of each Queoldiolan sundial incurs an opportunity cost of only 2 pounds of turnips.

On the other side of the exchange, Northwest Queoldiola is willing to accept as low as 2 pounds of turnips for each sundial. This is basically Northwest Queoldiola's supply price for exporting sundials to Csonda. If the "price" is any lower, then Northwest Queoldiola is better off consuming the sundials domestically.

Now, let's consider the opportunity cost of producing turnips.

• If Csonda switches a unit of labor from sundial production to turnip production, it is able to produce 60 pounds of turnips and in so doing gives up only 20 sundials. As such, the production of each pound of Csondan turnips incurs an opportunity cost of 1/3 (0.33) sundial.


• In contrast, if Northwest Queoldiola switches a unit of labor from sundial production to turnip production, it is able to produce 20 pounds of turnips and in so doing gives up 10 sundials. As such, the production of each pound of Queoldiolan turnips incurs an opportunity cost of 1/2 (0.5) sundial.

On the other side of the exchange, Northwest Queoldiola is willing to pay up to 0.5 sundial for each pound of turnips. This is basically Northwest Queoldiola's demand price for importing sundials from Csonda. If the "price" is any higher, then Northwest Queoldiola is better off producing the turnips domestically.

How About a Trade?

A Bit of Trade

• The Price of Sundials: Csonda incurs a cost of 3 pounds of turnips per sundial (its demand price) and Northwest Queoldiola incurs a cost of only 2 pounds of turnips (its supply price). Like any market price, the terms of trade for sundials is mutually agreeable to both sides. In this case, Csonda and Northwest Queoldiola are both willing to make a trade if the terms are between 2 and 3 pounds per sundial. If, for example, Csonda gave Northwest Queoldiola 2.5 pounds of turnips in each for each sundial (or 5 pounds of turnips for 2 sundials), then both nations are better off.


• The Price of Turnips: Now consider the other side of this trade. Northwest Queoldiola incurs a cost of 0.5 sundial per pound of turnips (its demand price) and Csonda incurs a cost of only 0.33 sundial (its supply price). Northwest Queoldiola won't go above 0.5 sundial and Csonda won't go below 0.33 sundial for each pound of turnips traded. If, Northwest Queoldiola gave Csonda 0.4 sundial per pound of turnips (which also works out to 2 sundials for 5 pounds of turnips), then both nations are better off.

Transit Costs

In the real world, the terms of trade between two countries is adjusted for transit cost. That is, the "buying" or importing nation pays a slightly higher price that the "selling" or exporting receives, with the difference used to pay transit cost.