ABSTRACT
A convenient expositional device, the assumption of a closed economy is unnecessarily limited in that it excludes from consideration a range of potentially economically significant transactions; hence, a second economy that trades with the first must be taken into explicit account in the analysis. The analysis of the effect on the domestic economy of trade with a second economy can proceed either under the assumption that the international, terms-of-trade are independent of the domestic country's demand for imports and supply of exports. Free trade can have no effect upon the domestic economy unless the international terms-of-trade differ from the price ratio obtaining in the home market in closed economy equilibrium. Like domestic prices in a closed economy, international prices also are a function of demand and supply, the equilibrium condition being that the excess demand for imports be zero in international markets.
