The Advantages of Free Trade (HL IB Economics)

The Benefits of International Trade

• International trade refers to the exchange of goods and services between countries

• International trade involves the exchange of goods/service through exports and imports

• International trade is 'free' when there is no government intervention (quotas, taxes etc.) to reduce or limit trade

The benefits of free trade

• Greater choice: with access to a wider variety of goods/services, the standard of living improves

• Lower prices: with international competition prices fall giving households the ability to buy more

• International cooperation: required for trade helps countries to build better relationships which leads to lower levels of hostilities

• Flow of new ideas: innovative ideas and technology can be shared between countries

• Access to resources: output can increase and costs of production can fall with increased access to raw materials

• Increased efficiency: international competition allows the most efficient firms to emerge and this improves the use of global resources

• Economic growth: exports are a key component of the gross domestic product of many countries and an increase in exports can lead to economic growth

• Economic development: Increased output leads to lower levels of unemployment which leads to higher incomes and a higher standard of living

The Benefits of Free Trade When World Price is Above Domestic Price

• The benefits of free trade can be seen for a country where the world price for a good/service is above the domestic price thus allowing for exports 

When the world price (W_P) is above the domestic equilibrium price (P_E ), a country's firms are able to export the excess supply 

Diagram Analysis

• The domestic equilibrium in the market for rice in Vietnam is at P_eQ_e

• The world price of rice is higher at P_w

• Vietnamese rice producers are incentivised by the higher prices to produce a higher level of output and domestic supply increases from Q_e to Q_s

• Vietnamese consumers now have to pay the world price for rice (Pw) and the domestic demand contracts from Q_e to Q_d

• The excess domestic supply (Q_s- Q_d) is now available for export

The Benefits of Free Trade When World Price is Below Domestic Price

• The benefits of free trade can be seen for a country where the world price for a good/service is below the domestic price thus allowing for imports
   

When the world price (Pw) is below the domestic equilibrium price (Pe), households and firms are incentivised to increase their imports 

Diagram Analysis

• The domestic equilibrium in the market for bananas in Sri Lanka is at P_eQ_e

• The world price of bananas is lower at P_w

• Some of Sri Lanka's firms cannot compete with the lower prices and domestic supply contracts from Q_e to Q_s

• Sri Lanka consumers benefit from the lower world price (Pw) and the domestic demand extends from Q_e to Q_d

• The excess domestic demand (Q_d- Q_s) is now met through imports