The Advantages of Free Trade (SL IB Economics)

• 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 are best understood when analysing markets in which:
  • The world price for a good/service is above the domestic price thus allowing for exports
  • The world price for a good/service is below the domestic price thus encouraging imports

 

1. World price is above the domestic price

 

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 (P_w) and the domestic demand contracts from Q_e to Q_d
• The excess domestic supply (Q_s- Q_d) is now available for export

 

2. World price is below the domestic price
 

When the world price (P_w) is below the domestic equilibrium price (P_e), 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 (P_w) and the domestic demand extends from Q_e to Q_d
• The excess domestic demand (Q_d- Q_s) is now met through imports