Answer to Question #132553 in Microeconomics for Neba

Question

Explain graphically how difference in demand and supply conditions between two hypothetical countries that produce wheat and cloth will lead to trade between the countries

Answer 1

Differences in demand and supply conditions promote trade between and amongst countries. Countries with excess supplies find other countries to be favourable markets and sources of demand, hence they export. On the other end, countries with shortages find it beneficial to import from other countries in order to augment their local supplies. Eventually, exportation and importation becomes a necessity where exchanges start to take effect between or amongst countries. To simplify the idea, let us suppose the existence of two countries, country A and country B. Let us assume country A has poor climatic conditions for wheat growth and hence poor wheat supplies locally, whereas country B has climatic conditions that favour wheat production and hence has a low local demand to clear the supplies. Also, country A has abundant resources for cloth supply resulting in it having excess cloth supplies, whereas country B has poor resources for cloth manufacture and hence shortages.

The poor wheat supplies in country A results in high prices as consumers compete for little output. Whereas in country B there are excess supplies of wheat. As a result, country A becomes a potential market for country B's wheat, whereas country A views country B as a source of wheat. Eventually, country B exports its surplus wheat to country A in order to increase demand, and country B imports the wheat from country A in order to augment its local supplies. The graphs below illustrates.

On the graphs above, Pw is the price without trade, Pt is the price with trade, Qw is quantity without trade, Qt is quantity with trade. As shown, before trade, country A has poor wheat supplies and hence high prices whereas country B faces a low demand and hence very low prices. Eventually, country A imports wheat from country B who has excess supplies. The supply curve the swivels from supply (w) to supply (t) and prices decrease from Pw to Pt, and quantities increase from Qw to Qt. On the other hand, country B experiences an increase in the demand from Demand (w) to Demand (t) resulting in prices increasing from Pw to Pt and quantities from Qw to Qt.

The same situations occur on the case of clothing, between two countries. The graphs below illustrates the effect of exchanges in clothing between country A and country B.

As shown above, exchanges in clothing are just in opposite to the exchanges in wheat due to changes in supply and demand conditions.

Thus, differences in supply and demand conditions between countries facilitate trade between them. Both countries to benefit since surpluses and shortages are addressed. A country with poor supplies imports from the country with poor demand and excess supplies. A country with excess supplies and low demand exports to the one with shortages and high demand. Countries becomes markets themselves; wealth is exchanged and both benefit from trade exchanges.