Gains From Trade
Definition
Specialisation: the concentration by a country, firm or worker on producing a narrow range of goods or services.
Free trade: international trade that takes place without barriers such as tariffs, quotas or subsidies.
Main Gains
- Consumers gain a wider range of goods at lower prices, because imports come from the lowest opportunity-cost producer.
- Firms exploit economies of scale by selling to a larger market, so average costs fall and prices can drop further.
- Greater foreign competition forces domestic firms to cut waste, so efficiency and choice rise.
- Trade transfers technology and ideas between countries, which can raise long-run productive capacity.
Key Idea
- Trade widens choice, lowers prices and raises consumer surplus.
- It also brings economies of scale, competition and technology transfer.
- But the gains are not shared equally between or within countries.
Worked Example
- Take two countries, Ukraine and Bangladesh, each with two workers who can make wheat or cloth.
- Before trade, each country puts one worker on each good.
- We compare world output before and after full specialisation.
Example
- Ukraine can make 10 wheat or 8 cloth per worker; Bangladesh can make 8 wheat or 10 cloth per worker.
- In Ukraine, the opportunity cost of 1 wheat in cloth is:
- In Bangladesh, the opportunity cost of 1 wheat in cloth is:
- Ukraine's 0.8 cloth < Bangladesh's 1.25 cloth, so Ukraine specialises in wheat and Bangladesh in cloth.
- Before specialising, world output is 18 wheat + 18 cloth.
- After full specialisation, Ukraine makes 20 wheat and Bangladesh makes 20 cloth.
- World output rises to 20 wheat + 20 cloth, a gain of +2 in each good with no extra resources.
Trading Possibility Curve
Definition
Trading possibility curve: the combinations of two goods a country can consume once it specialises and trades at the world price ratio, usually lying beyond its own production possibility curve.
- Without trade, a country is limited to consuming points on its own production possibility curve.
- Specialisation frees its resources for one good, and it then swaps some of that output for the other good at the terms of trade.
- The resulting consumption line is straight because every extra unit trades at the same fixed price ratio, unlike the curved production possibility curve.
- Because this line lies outside the production possibility curve, the country reaches bundles it could never produce alone.
Note
- Suppose Ukraine and Bangladesh trade at 1 wheat for 1 cloth, a rate between their opportunity costs.
- Having specialised, Ukraine produces 20 wheat and exchanges 8 wheat for 8 cloth.
- Ukraine then consumes 12 wheat and 8 cloth, a bundle beyond its own production possibility curve.
- Producing 12 wheat itself would leave resources for only about 6 cloth, fewer than the 8 gained through trade.
Costs of Trade
- A country can become over-dependent on a few trading partners or products, so a partner's downturn hits it hard.
- Declining sectors can suffer structural unemployment as cheaper imports win out, because displaced workers lack the skills to move quickly.
- Open economies are more exposed to external shocks transmitted through trade.
- Rising transport and production can also bring environmental damage.
Note
- Older heavy industries such as coal and steel have declined in many economies as cheaper imports won out, costing jobs.
- A shock abroad can quickly spread to a trade-dependent economy.
- So the losers from trade are often concentrated in particular regions.
Evaluation
- In favour of trade, lower prices, wider choice and scale raise living standards.
- Against trade, structural unemployment, dependence and shocks impose real costs.
- The gains are spread unevenly, so some groups and regions lose out.
- On balance trade tends to raise total welfare, but it depends on how far the losers are compensated and retrained.
Exam technique
- Set the gains against the costs rather than listing benefits alone.
- Stress that gains and losses are unevenly distributed.
- Reach a supported, context-specific judgement.
Common Mistake
- Do not list benefits without recognising that the gains are unevenly distributed.
- Some groups and regions can lose even when a country gains overall.
Self review
- Define specialisation.
- Name three gains from free trade.
- What does the trading possibility curve show?
- Why does its slope depend on the terms of trade?
- Who tends to lose from free trade?
