IBEconomicsDPSLRevision Notes4. The Global Economy4.1 Benefits of International Trade4.1.1 The Advantages of Free Trade

The Advantages of Free Trade (DP IB Economics)

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DP Economics: SLDP Economics: HL

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

6-2-2-the-benefits-of-free-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 

4-1-1-diagrammatic-illustration-of-free-trade---pw-above-world-price

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]

ibdp-economics---world-price-above-domestic-price

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

Export space sales space revenue space equals space price space straight x space quantity Export space sales space revenue space equals space $ 25 space straight x space 30 comma 000 space space Export space sales space revenue space equals space $ 750 comma 000 space[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
     

4-1-1-diagrammatic-illustration-of-free-trade---pw-below-world-price

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]

ibdp-eocnomics---world-price-below-domestic-price


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

Consumer space import space expenditure space equals space price space straight x space quantity Consumer space import space expenditure space equals space $ 2.50 space straight x space 48 comma 000 space space Consumer space import space expenditure space equals space $ 120 comma 000 space[2 marks]

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