Gain from trade when prices are distorted?

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I have started studying managerial economics as part of my MBA, and it has been great knowing about the economic principles, interdependence, and the gain from trade. I can see how specialization based on comparative advantage helps a country/party in the trade. However, do the two countries possibly engage in a business where the prices are distorted? Is this even possible? It may be possible if one nation is mighty and dictating the terms in a way that is disadvantageous to other countries, but I cannot find a real-life example to understand it better. Is there any example in the current scenario where this holds?


Indeed, one answer to a fundamental question in international trade -- why do countries trade? -- is that specialization based on comparative advantage leads to gains from trade for all countries. This same principle also applies at the individual level: I completely specialize in producing and selling educational “goods”, and I buy everything else from others. And I am better off relative to being self-sufficient -- producing everything myself. Gains from trade! 

However, there are nuances: it is well known amongst academic trade economists, for example, that under some circumstances a large (think GDP) country can gain by unilaterally raising its tariff rates if the other countries are passive. This is known as the unilaterally optimal tariff: a tariff level in which a country can improve its welfare – any level below or above it will lower the welfare of the country imposing the tariff. Effectively, by imposing tariffs the large country is distorting prices in such a way as to improve its terms of trade. Of course, one cannot simply assume that other countries will remain passive and an ensuing trade-war would see both parties end up losing overall.

A more potent example of countries exerting market power is in the oil industry, which produces an interesting global dynamic and takes economists squarely into the realm of game theory. Consider, for example, OPEC that is a consortium of 13 oil-producing countries, which act like a single monopolist to distort prices globally and improve profits. See the link below for an interesting non-technical article on this. 


Answered by:
Gary Lyn
Assistant Professor
Last updated on July 8, 2022