The Advantages of Free Trade (HL IB Economics)
Revision Note
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 (WP) is above the domestic equilibrium price (PE ), 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 PeQe
The world price of rice is higher at Pw
Vietnamese rice producers are incentivised by the higher prices to produce a higher level of output and domestic supply increases from Qe to Qs
Vietnamese consumers now have to pay the world price for rice (Pw) and the domestic demand contracts from Qe to Qd
The excess domestic supply (Qs- Qd) is now available for export
Worked Example
The Ukraine is one of the world's largest grain producers and due to their comparative advantage, their domestic price is below the world price.
From the diagram below
a) Calculate the quantity of exports [2]
b) Calculate the export revenue received [2]
Answer:
a) Calculate the quantity of exports
Step 1: Determine Ukraine's excess supply to be exported
Domestic prices will rise to the world price. At this price the quantity demanded (Qd) is 40,000 kg's and the quantity supplied is 70,000 kg's [1 mark]
The quantity of exports = 70,000 - 40,000 = 30,000 kg's [1 mark]
b) Calculate the export revenue received
Step 1: Substitute figures into the sales revenue equation
[2 marks]
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 PeQe
The world price of bananas is lower at Pw
Some of Sri Lanka's firms cannot compete with the lower prices and domestic supply contracts from Qe to Qs
Sri Lanka consumers benefit from the lower world price (Pw) and the domestic demand extends from Qe to Qd
The excess domestic demand (Qd- Qs) is now met through imports
Worked Example
Sri Lanka consumers enjoy their bananas. Many bananas are grown locally, however their domestic price is higher than the world price creating an incentive to import bananas. Many bananas are imported from India.
From the diagram below
a) Calculate the quantity of imports [2]
b) Calculate the import expenditure [2]
Answers:
a) Calculate the quantity of imports
Step 1: Determine Sri Lanka's excess demand to be imported
Domestic prices will fall to the world price of $2.50. At this price the quantity supplied (Qs) is 25,000 kg's and the quantity demanded (Qd) is 73,000 kg's [1 mark]
The quantity of imports = 73,000 - 25,000 = 48,000 kg's [1 mark]
b) Calculate the import expenditure
Step 1: Calculate consumer expenditure on imports
[2 marks]
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