Question

If a good sold for different prices in different locations, then why would trade be likely? What would likely happen to prices and employment with trade? Why?

Answer 1

The law of one price is an economic concept that states that the price of an identical asset or commodity will have the same price globally, regardless of location, when certain factors are considered.

Law of one price does not always hold true.

For eg, if a product is maufactured in Mumbai, then it will be sold at a lower price in mumbai and at a higher price in Delhi, due to transportation costs. Real world example is bread.

Another example could be due to trade barriers. If one country applies tariff or quota on other country then the prices of the same product differs between countries.

Say India imports mobile phones from China. The main reason is that China sells at a very cheap cost. Say China sells it at 100 in India, 90 in China. Still trade happens, why so? Because if India produces mobile phones, it will be sold in India not below 110. So, due to these reasons trade is likely.

Putting it in terms, if a country has absolute advantage (fewer resources or lower cost) or comparative advantage (lower opportunity cost) for a Product then that country should export this Product.

There are benefits of trade, as well as costs of trade

Benefits

1. Prices will be less for importing countries as compared to domestic production

Costs

1. Employment will be hurt for that industry. Import of mobile phones hurts mobile manufacturing industry in India, and unemployment rises.

2. For exporting country, if that country is small, then it may export most of the products to the rest of the world. This will increase domestic prices for them, which is not a good sign. In such scenarios voluntary export restraint is applied so that domestic demand is fulfilled. This does not happen in case of a large country with a large production capacity.