Consider a product with a perfectly competitive market. Carefully explain why nations gain from engaging in international trade in this product. Do nations gain equally from trade? If not, what determines which country gains more? (In your answer you can assume a two-country world.)

Question

What will be an ideal response?

Answer 1

POSSIBLE RESPONSE: Assuming a two-country world, demand and supply differ in the two countries, so prices also differ if there is no international trade. With the opening of international trade, arbitrage opportunities arise: opportunities to make a profit by buying the good cheaper in one country and selling it in another. Due to this international trade the prices in the two countries equalize. The gain from trade in the importing country arises because consumers in this country gain more than producers lose as a result of the reduced price. The gain from trade in the exporting country exists because producers gain more than local consumers lose. In general, nations do not gain equally from trade. The country which experiences a larger change in its price stands to gain more. The country with the less elastic (steeper) trade curve (import demand curve or export supply curve) gains more. More precisely, the national gain from trade is proportional to the change in the price that occurs due to the shift from no trade to free trade.