Terms of trade based on comparative advantage

Steps:

• Calculate opportunity costs: Northland's 1 food costs 2.5 drinks (10/4); Southland's 1 food costs 1.67 drinks (20/12).
• Determine specialization: Southland has lower opportunity cost for food (1.67 < 2.5), so specializes in food; Northland specializes in drinks.
• Identify beneficial trade range: Exchange rate (drinks per food) must satisfy 1.67 < X < 2.5 for both to gain over autarky.
• Evaluate choices: Only X=2 falls within this range.

Why B is correct:

• 2 drinks per food lies between Southland's (1.67) and Northland's (2.5) opportunity costs, ensuring gains from trade per Ricardo's comparative advantage theory.

Why the others are wrong:

• A: 1 drink per food is below 1.67; Southland gets fewer drinks than autarky, no benefit.
• C: 3 drinks per food exceeds 2.5; Northland pays more than autarky, no benefit.
• D: Same as C; 3 drinks per food exceeds 2.5, no benefit for Northland.

Final answer: B