Question

Two countries decide to engage in specialization and exchange with each other. As a result, we can expect:

a the price of imported goods to rise and the price of exported goods to fall.

b the price of imported goods to fall and the price of exported goods to rise.

c the prices of all traded goods to decline.

d the prices of all traded goods to increase.

Answer 1

If two countries engage in specialization and begin trading with each other, each country would specialize in the products and services in which they have a comparative advantage or in other words, it would take relatively lower opportunity cost to produce those particular goods and services given a certain amount of productive resources or factor/input endowments in each country. Therefore, the products or services in which a particular country has a comparative advantage could be produced abundantly in that country and the domestic markets for those products and services would experience an excess supply as the country would predominantly specialize in the production of those goods and services enabling it to completely fulfill the consumer demand in the domestic markets and still have an excess supply left. Thus, the domestic prices of those goods and services in the exporting country would be relatively lower. The excess amount of those goods and services in the domestic market could then be exported to the other country which does not have a comparative advantage on production of those goods and services relative to the exporting country, considering the difference in the factor/input endowments between the importing and exporting country. Hence, the exporting country can economically gain from selling those products and services at relatively higher prices to the other or importing country than the domestic prices for those goods and services. On the other hand, the importing country would experience a shortage in the domestic markets for those goods and services as the domestic producers or firms are not able to produce and supply adequate quantities of the goods and services to fulfill the overall consumer demand as the country lacks the necessary factor/input or resource intensity/availability to abundantly or adequately produce/supply the concerned goods and services. Hence, the domestic prices of those goods and services in the importing country would be relatively high due to higher consumer demand and lower or inadequate supply level and the importing country can economically gain from trading by importing those goods and services at a relatively lower price compared to their domestic prices in the importing country. Therefore, the answer, in this case, would be option b given in the answer choices or options or the price of imported goods to fall and the price of exported goods to rise.