Gains from Trade
Economics: IB Diploma, topic 3.5.2
Benefits of International Trade
Free trade is defined as “the free movement of goods and services cross-border between countries with no attempt from government to unfairly restrict imports from, or exports to, other countries.”
Improved allocative efficiency
- Free trade improves allocative efficiency.
- Free trade improves the efficiency of resource allocation because countries produce in sectors they are better suited to, rather than all goods and services.
- The more efficient use of resources leads to higher productivity and increasing total domestic output of goods and services.
Higher global output
- Comparative advantage theory states that, if countries specialize in goods and services, have a lower opportunity cost of producing than other countries, and engage in free trade, they have the possibility of achieving an allocation of resources outside their initial PPC.
Greater competition and choice
- Free trade causes increased competition, which will lead to cheaper prices and higher consumer surplus.
- The reduction in prices increases real incomes, increases purchasing power and allows more goods and services to be bought. So this increases standard of living.
- Free trade brings down cost-push inflationary pressure.
- Free trade increases choice. Free trade allows countries to consume bananas even if they don’t have the climate for it.
Economies of scale
- Firms and countries can specialize in the production of a small range of good and services, and trade them with other countries.
- Because firms can focus on producing a few goods and services, there is scope for more economies of scale, lower long-run average cost, lower prices, higher consumer surplus and increased demand for goods.
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Expanding beyond the PPC
- The image above shows two PPCs, for the U.S. and Mexico.
Expanding beyond the PPC
- With 40 workers, the United States can produce either 10,000 shoes and zero refrigerators or 40,000 refrigerators and zero shoes.
- With 40 workers, Mexico can produce a maximum of 8,000 shoes and zero refrigerators, or 10,000 refrigerators and zero shoes.
- Point A on both graphs is where the countries start producing and consuming before trade. Point B is where they end up after trade, due to the benefits of each country specializing in the good where they have the lowest opportunity cost (and hence a comparative advantage).
Test yourself on Gains from Trade
Which of the following are advantages of international trade?