32.2 The Determination of Trade
Patterns LO 3, 4
The law of one price says that the national prices of tradable goods
(net of taxes and tariffs) must differ by no more than the costs of
transporting these goods between countries. After accounting for
these transport costs, there is a single world price.
Countries will export a good when the world price exceeds the price
that would exist in the country if there were no trade. The low no-
trade price reflects a low opportunity cost and thus a comparative
advantage in that good. Thus, countries export goods for which they
have a comparative advantage.
Countries will import a good when the world price is less than the
price that would exist in the country if there were no trade. The high
no-trade price reflects a high opportunity cost and thus a comparative
disadvantage in that good. Thus, countries import goods for which
they have a comparative disadvantage.
The terms of trade refer to the ratio of the prices of exports to the
prices of imports. The terms of trade determine the quantity of
imports that can be obtained per unit of exports.
An improvement in the terms of trade—a rise in export prices relative
to import prices—is beneficial for a country because it expands its
consumption possibilities.