The Benefits of Trade [ Biz/ed Virtual Developing Country ]

The Virtual Developing Country is a case study of Zambia. There are a series of field trips available looking at different issues connected with economic development. This tour is the trade tour, and this page looks at the theoretical benefits of international trade.

Theories

The Benefits of Trade

Next theory - The Principle of Absolute and Comparative Advantage >>

There are a number of benefits the citizens and firms of a country may enjoy as a result of being able to trade freely with the citizens and firms of another country.

  • The benefits of specialisation
  • The benefits of competition
  • The benefit of choice

By specialising in the production of goods and services the firms of a country will produce with a higher level of productive efficiency. The surpluses produced can then be traded with the surpluses of other countries. By specialising in the production of goods and services where there is an absolute or comparative advantage there is an overall gain in welfare. Increased global competition will encourage allocative and productive efficiency.

The concepts of consumer and producer surplus can be used to assess the benefits of free trade. The different between the amount that consumers would be prepared to pay for a good or service rather than go without, and the price that they actually pay is called consumer surplus. It is used as a measure of satisfaction or welfare of consumers. The difference between the price that producers would be prepared to sell their produce at and the price that they actually sell it at is the producer surplus. These two together are a measure of the welfare of the product.

Benefits of free trade

In a perfectly competitive market in a closed economy where the equilibrium market price and quantity is Q0 and P0, the consumer surplus is shown by the area ABC. The producer surplus is shown by the area CB0. The total level of welfare would be equal to the area AB0.

If the country now takes part in world trade, citizens of that country can now buy goods and services at the world price of Pw . This is below the domestic equilibrium market price of P0. The horizontal world price line indicates that domestic producers have to accept the world price and cannot influence it due to their limited size. They are price takers. Domestic consumers can purchase all they need from other countries at the price Pw. In the model above domestic consumers will consumer Q2 of which Q0 will be purchased from domestic producers and Q2-Q0 imported.

As a result of international trade consumer surplus has increased to ADPw. Consumers have gained CBFPw of consumer surplus at the expense of domestic producers who have seen their producer surplus fall to PwF0. Consumers have also gained consumer surplus, FBG as they are now able to buy the good from more efficient foreign producers. There is also an additional gain in welfare, BGD, which has resulted from consumers simply buying more goods because of the lower price. Overall society has experienced a welfare gain of BFD.

In addition it should noted that consumers have also gained as a result of additional choice. As many factors of production are not geographically mobile world trade will increase the range of choice of goods and services that people can enjoy.

Next theory - The Principle of Absolute and Comparative Advantage >>


Related Glossary Items:
Consumer surplus
Producer surplus
Comparative advantage
Absolute advantage
Factors of production

Related Issues:
Economic Efficiency
Zambia's Exports and Imports
Zambia's Balance of Payments Situation

Related Theories:
Economic Efficiency
The Principle of Absolute and Comparative Advantage