Why Do Nations Trade?

By Garima Dikshit

Trade of goods and services has always considered as a path of economic development for a nation. Trade, in simple words, defined as the import and export of goods and services between the nations. A nation can have as much trading partner it wishes to have. Two nations trade because no nation can produce all the goods and services in the most efficient manner i.e. the lowest efficient cost. There may be some situations that two nations can produce goods in an equally efficient way with equal cost but still, there can be differences in the price of these commodities in their home nation due to differences in the income level of two nations.

To better understand this concept let us take an example:

Suppose we have two nations A and B both the nations are producing a commodity named as ‘X’ Now, Country A has a higher level of income with strong taste and preference for commodity ‘X’ so the demand for this commodity in country A will automatically tend to fix a higher price. Whereas Country B has a lower income level with lower taste and preference for a similar commodity in such case the price of the product tends to be low as compared to that of country A, even if the cost of producing the commodity in both the nation is the same. Now the question here arises that if both the nations can produce the commodity in an equally efficient manner then what is the need for trade.

The trade between the two nations takes place because of the difference in product prices. Although the import and export are also dependent on the prices of the particular commodity in any nation. The difference in prices arises due to differences in the demand and supply conditions and differences in the elasticity of demand and supply in a nation.

Here we have two nations considering as home country and the foreign country. DD is the demand curve and SS is the supply curve for the home and foreign nation. The demand condition in both the nation is same but there is a difference in the supply condition, the supply curve of the home nation is less than elastic and that of the foreign nations supply curve is more than elastic. The price in the home country is H and the price in a foreign country is F. Here, the price level in the home country is higher than price level in the foreign nation which also shows that home nation has strong taste and preference for commodity X (H>F). Higher price in the home country attracts import of the goods into this country from the foreign country where the price of that good is relatively lower. Therefore, there will be profit in purchasing commodity from the foreign country. Once the two-nation brought together into a trade relationship with each other, the foreign nation would emerge as an exporter and home nation will emerge as an importer. Both nations will equalize their price at point P is shown with the broad dot where the home country will import some amount of X commodity from a foreign country (shown by red triangle), and the foreign country will export some share of X commodity to the home country (shown by a blue triangle).

H is the price in the home country and F is the price in a foreign country. Here again, H > F , Profit will be in purchasing goods from a foreign nation, Both the nations will equalize their price at point P where the home country will import from a foreign country will export to the home country.

Same as all the above cases the price of the commodity is higher in the home country depending upon the demand and supply conditions. As a foreign country is selling a similar product at a much lower price as compared to the home nation both the nations will equalize their price at point P.Considering the entire concept the international trade between the two nations will take place until the price are equalized in both the nation.

Originally published at https://www.studentsofeconomics.com.