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What is Free Trade?
• Free trade represents trade between countries
without the introduction of artificial barriers
• International trade reflects exchange and
specialization
• Exchange: countries supply goods and services
that they can produce relatively cheaply and buy
products from other countries that they would
find relatively expensive to produce
• Specialisation: benefits from trade are increased if
there are economies of scale from production and
if countries specialise their resources in producing
certain commodities
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What is Free Trade?
• In an open economy, one nation trades
openly with other
• Trade in goods
• Trade in services
• Free flow of financial capital
• Free flow of labour resources
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Intra-Firm Trade
• Intra-firm trade is becoming increasingly important
• For example a USA fruit drinks manufacturer might export some
of its raw materials to the UK to produce fruit juices that are
manufactured / bottled and distributed to the UK and Western
European markets
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The Potential Advantages from
Trade (1)
• Competition:
• Increased competition for suppliers
• Greater pressure on businesses to keep their costs and prices
down
• Increased competition can lead to a dilution of monopoly power
– which reduces the potential for exploiting consumers
• This leads to an improvement in the allocative efficiency of scarce
resources
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The Potential Advantages from
Trade (2)
• Comparative Advantage:
• If other countries can supply certain goods and services more
efficiently – it makes economic sense for them to do so
• This makes use of the principle of comparative advantage
• It also leads to an improvement in overall productive efficiency
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The Potential Advantages from
Trade (3)
• Improvements in dynamic efficiency
• Trade tends to speed up the pace of technological progress and
innovation across different industries
• Trade provides more choice for consumers
• Dynamic efficiency gains become apparent over time – for
example improvements in the quality and performance of
products at a given price
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The Potential Advantages from
Trade (4)
• Economies of scale (lower LRAC) – representing gains in
productive efficiency and leading to higher profits and lower
prices for consumers
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The Potential Advantages from
Trade (5)
• Trade is seen as a stimulant to short term aggregate demand
and long run economic growth
• Exports are an injection of aggregate demand
• A boost to exports will have multiplier effects on the level of
equilibrium national income
• There may be extra supply-side improvements from increased
capital investment between companies and countries engaged in
international trade
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Micro and Macroeconomic
Gains
Imports of new
technology –
LRAS effect
Employment
creation in growth
sectors
Stimulates new
capital investment
and innovation
Makes domestic
markets more
contestable
Transfer of ideas
and best practice -
“benchmarking”
Injection of AD –
Export led growth
– multiplier effects
International Trade
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Concept of Comparative
Advantage
• First developed by David Ricardo, one of the founding fathers
of classical economics, in 1817
• Comparative advantage exists when for a country
• The opportunity cost of production is lower
• A country is more productively efficient than another
• Countries will tend to specialise in and then export products
which use intensively the factors which it is best endowed
• Exports used to finance imports of other products
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Importanceoftradefordevelopingcountries
Less dependence
on volatile primary
industries
Imports of
investment goods
– boosts LRAS
Exploitation of
comparative
advantage
Transfer of
technology and
ideas
Employment and
higher real wages
in export sectors
Diversification
into
manufacturing
Importance of trade for
developing countries
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