4.1.1 Benefits of International Trade Notes

International trade brings in a number of benefits. However, there are even greater benefits if the trade is free.

Benefits of International Trade

Increased competition

International trade exposes domestic firms to global competition.

1. The competition pushes domestic producers to improve the quality of their products, while also trying to minimise their costs of production in order to stay competitive against foreign firms and their respective prices.
2. This leads to domestic firms to becoming more efficient and reducing prices for consumers.

Lower prices for consumers

1. International trade allows foreign companies to enter the markets at lower prices. Thereby, consumers are able to buy less expensive products.
2. Further, as international trade leads to increased competition and increased efficiency for domestic firms, this will also lead to a reduction in prices of domestic products for consumers.

Greater choice

1. With international trade, countries can import various goods and services from other countries.
2. This enables consumers to have a greater choice of products.

Acquisition of resources

1. Countries can import natural resources (timber or oil) or capital goods (machinery) that are unavailable domestically.
2. This allows them to expand their production capabilities.

More foreign exchange earnings

1. When exporting goods, countries acquire foreign currencies which can be utilised to pay for imports from other countries.
2. It can also be used to make payments abroad (we will explore this concept in subtopic 4.6)

Access to larger markets

1. Domestic firms can grow and expand their production by selling products in international markets if the output of the firm is limited by the size of the domestic market.
2. This leads to larger sales and a larger consumer base for the firm.

Economies of scale

1. Increasing the market size for a firm from domestic markets to domestic and international markets causes the demand to increase.
2. This causes to the production level and size of production to increase as well, which leads to a fall in average costs and provides economies of scale to the firms.
3. This allows the firms to reduce their prices for consumers too.

More efficient resource allocation

1. When free trade takes place, each country specialises in producing the goods and services it can produce more efficiently with a lower cost of production than other countries.
2. This reduces the waste of scarce resources and thereby more efficient resource allocation.

More efficient production

1. The competition from foreign firms forces domestic firms to improve their quality of the product and reduce costs of production in order to retain its revenue and supply to the market.
2. This leads to a more efficient production from domestic firms.

Free Trade

• Under free trade, the prices of goods and services that are imported and exported are determined solely by the market forces of demand and supply.

The scenario below show the different trade scenarios for the sale of cloth.

Diagram Calculations

Key notations:

1. The x-axis denotes the quantity of the good, labelled as Q
2. The y-axis denotes the price of the good, labelled as P
3. Sd and Dd refers to the domestic supply and domestic demand at the country of choice respectively
4. Qd refers to the overall quantity demanded and Qs refers to the overall quantity supplied of the good
5. Pd refers to the domestic price of the mentioned good at the respective country
6. Pw refers to the world price and world supply curve for the mentioned good

World market price:

1. In Figure 1, the world price Pw for cloth in this scenario is dictated by the world demand and world supply of cloth.
2. The world demand for cloth is the sum of each countries demands and the world supply for cloth is the sum of each countries supplies.
3. Every country that participates in this free trade buys and sells cloth at this world price Pw.

Exports under free trade:

1. As observed in Figure 2, when under free trade, the country Tradeland will export a good, in this case cloth, only when the domestic prices Pd are lower than the world price Pw.
2. If Tradeland decides to export cloth to other countries, the domestic price is not relevant anymore and the price of cloth will be Pw both domestically and internationally
3. Due to the increase in price from Pd to Pw, less number of domestic consumers demand cloth at Qd (Law of Demand) and a higher quantity of cloth is supplied by the producers at Qs (Law of Supply).
4. Therefore, the producers of cloth at Tradeland sells Qd quantity of cloth to domestic consumers and the excess supply of Qs-Qd is exported to other countries and sold.
5. The quantity of exports can be determined by Qs-Qd and the export revenue earned from this can be calculated by doing: $$(Qs-Qd)*Pw$$

Imports under free trade:

1. As observed in Figure 3, when under free trade, the country Tradeland will import a good, in this case cloth, only when the domestic prices Pd are higher than the world price Pw.
2. If Tradesoles decides to import cloth from other countries, the domestic price is not relevant anymore and the price of cloth will be Pw both domestically and internationally.
3. Due to the decrease in price from Pd to Pw, more number of domestic consumers demand cloth at Qd (Law of Demand) and a lower quantity of cloth is supplied by the producers at Qs (Law of Supply).
4. Therefore, the producers of cloth at Tradeland sells Qs quantity of cloth to domestic consumers and the excess demand of Qd-Qs is imported from other countries and sold.
5. The quantity of imports can be determined by Qd-Qs and the import expenditure from this can be calculated by doing: $$(Qd-Qs)*Pw$$