THE WORLD PRICE AND COMPARATIVE ADVANTAGE

The first issue our economists take up is whether Isoland is likely to become a steel importer or a steel exporter. In other words, if free trade is allowed, will Isolandians end up buying or selling steel in world markets? To answer this question, the economists compare the current Isolandian price of steel to the price 01 steel in other countries. We call the price prevailing in world markets the world price. If the world price 0 steel is higher than the domestic price, then Isoland will export steel once trade is permitted. Isolandians steel producers will be eager to receive the higher prices available abroad and will start selling their steel Isoland will import steel Because foreign sellers offer a better price, Isolandian steel consumers will
quickly tart buying steel from other countries. In comparing the world price and the domestic price before trade indicates whether Isoland has a comparative advantage in producing steel. The domestic price reflects the opportunity cost of steel It tells us how much an Isolandian must give up to get one unit of steel. If the domestic price is low, the cost of producing steel in Isoland is low, suggesting that Isoland has a comparative advantage in producing steel relative to the rest of the world. If the domestic price is high, then the cost of producing steel in Isoland is high, suggesting that foreign countries have a comparative advantage in producing steel As we saw in Chapter 3, trade among nations is ultimately based on comparative advantage. That is trade is beneficial because it allows each nation to specialize in doing what it does best. By comparing the world price and the domestic price before trade, we can determine whether Isoland is better or worse at producing steel than the rest of the world.

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