Two-Country Trade Theory: Comparative Advantage

Country 1

Autarky price $P_1^A$—

Autarky qty $Q_1^A$—

Trade price $P^W$—

Production $Q_1^S$—

Consumption $Q_1^D$—

Exports $X_1$—

World Market

World price $P^W$—

Volume of trade $Q^W$—

Direction—

$P_1^A$ vs $P_2^A$—

Total gains from trade—

Country 2

Autarky price $P_2^A$—

Autarky qty $Q_2^A$—

Trade price $P^W$—

Production $Q_2^S$—

Consumption $Q_2^D$—

Imports $M_2$—

Country 1 (potential exporter)

Demand intercept $a_1$ 110

Demand slope $b_1$ 1.00

Supply intercept $c_1$ 5

Supply slope $d_1$ 1.00

Country 2 (potential importer)

Demand intercept $a_2$ 100

Demand slope $b_2$ 1.00

Supply intercept $c_2$ 40

Supply slope $d_2$ 1.00

Functional forms

Each country has linear demand and supply:

$D_i(P)=a_i-b_i\,P$

$S_i(P)=\max(0,\,-c_i+d_i\,P)$

Autarky: $P_i^A=(a_i+c_i)/(b_i+d_i)$. World price clears $X_1=M_2$.

Display

Show autarky prices Show world price link Shade trade quantities

How to read this diagram

Each country has its own demand curve $D_i(P)=a_i-b_i P$ and supply curve $S_i(P)=\max(0,\,-c_i+d_i P)$. In autarky, each market clears at its own price $P_i^A$ where $D_i=S_i$.

The middle panel constructs the world market by horizontally summing Country 1's excess supply $ES_1(P)=S_1(P)-D_1(P)$ for prices above $P_1^A$ and Country 2's excess demand $ED_2(P)=D_2(P)-S_2(P)$ for prices below $P_2^A$. They intersect at the world price $P^W$, which clears global trade: $X_1=M_2$.

The horizontal dashed line at $P^W$ is the bridge across all three panels — it's the same price everywhere under free trade. At that price, Country 1 produces more than it consumes (the gap is exports) and Country 2 consumes more than it produces (the gap is imports). The country with the lower autarky price has the comparative advantage and becomes the exporter.