Monopoly

In the numerical example, prices are proportionate to costs. This will be true as long as the prices are determined by competitive supply and demand. But what if some of the prices are not determined by supply and demand, but are influenced by monopoly power?

This is a very old question, but it is not clear that there are any very satisfactory answers to it. It seems that monopoly points in two directions at once. On the one hand, the country with monopoly power may benefit from the profits the monopoly can earn. On the other hand, monopolies push up the price and their profits by cutting back on sales. This means less trade, and since trade according to comparative advantage is mutually beneficial, it is possible that monopoly power could make both countries worse off.

There is also another side to this coin. Monopoly may itself be a result of government limitations of trade. If the domestic market in a particular industry is only big enough for one producer, and there is no trade, then that industry will be a monopoly. But a world market could still be big enough for competitive producers. In that sort of case, the way to get more competition is to open the country to trade. In addition to its other benefits, openness to trade can limit monopoly power.

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