price of an internationally traded product may be influenced greatly, or
only slightly, by the demand and supply coming from any one country.
The extent of one country’s influence will depend on how important its
quantities demanded and supplied are in relation to the worldwide totals.
The simplest case for us to study arises when the country, which we will
take to be Canada, accounts for only a small part of the total worldwide
demand and supply. In this case, Canada does not itself produce enough
to influence the world price significantly. Similarly, Canadian purchases
are too small a proportion of worldwide demand to affect the world price
in any significant way. Producers and consumers in Canada thus face a
world price that they cannot influence by their own actions.
In this case, the price that rules in the Canadian market must be the world
price (adjusted for the exchange rate between the Canadian dollar and
the foreign currency). The law of one price says this must be so. What
would happen if the Canadian domestic price diverged from the world
price? If the Canadian price were below the world price, no supplier
would sell in the Canadian market because higher profits could be made
by selling abroad. The absence of supply to the Canadian market would
thus drive up the Canadian price. Conversely, if the Canadian domestic
price were above the worldwide price, no buyer would buy from a
Canadian seller because lower prices are available by buying abroad. The
absence of demand on the Canadian market would thus drive down the
Canadian price.