International Trade - Theory and Policy, 2010a

These shifts in supply will continue as long as the prices for the goods continue to differ between the two
markets. Once the prices are equalized, there will be no incentive to trade any additional amount.
Equalized prices mean that a pound of cheese will trade for the same number of gallons of wine in both
markets. The free trade prices will be those prices that equalize total supply of each good in the world with
total demand for each good.
As a result of trade, the price ratio, or terms of trade, will lie in between the two countries’ autarky price
ratios. In other words, the following inequality will result:
(PCPW)Aut aLCaLW.
Note that this inequality will be true as soon as the price deviates from the autarky price and long before
the free trade prices are reached. This also means that shortly after trade begins, the price of cheese
(measured in terms of wine) exceeds the cost of producing cheese (also measured in terms of wine).
Normally, when we measure the price and cost in dollar terms, when the price per unit exceeds the cost
per unit, then positive profit is realized. The same is true when we measure the price and cost in terms of
wine. Thus as soon as trade begins to change prices, cheese production becomes more profitable in the
United States. And because we assume people are profit seeking, they will therefore seek to expand cheese
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