4.1 The advantages of free trade

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7 Terms

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international trade

refers to the exchange of goods and services between countries

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benefits of free trade

  • Greater choice, better standard of living

  • Lower prices due to international competition

  • Access to resources: output can increase, and costs of production can fall with increased access to raw materials

  • Increased efficiency since competition improves efficiency

  • Economic growth

  • Economic development since increased output means lower levels of unemployment


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The Benefits of Free Trade When World Price is Below Domestic Price

  • Consumers Win (Big): Prices drop, so people buy more and save money. Their overall welfare (Consumer Surplus) expands significantly.

  • Producers Lose: Local businesses face cheaper competition, so they cut back production and lose revenue (Producer Surplus).

  • The Net Result: The gains to consumers are larger than the losses to producers. This creates a net economic bonus (Net Welfare Gain) for the country as a whole.


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comparative advantage

a country should specialise in the goods/services that it can produce at the lowest opportunity cost because:

  • By specialising, the volume of production increases

  • Excess production can be exported

  • Goods/services which are not produced in the country can be imported


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absolute advantage

Occurs when a country is able to produce a product using fewer factors of production than another country.

A country may well have absolute advantage but still not have comparative advantage.


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sources of comparative advantage

  • natural resources (countries with more abundance)

  • labour forces (higher skilled workforce)

  • technology (better technology and innovation)

  • capital and infrastructure (the availability and quality of both)

  • economies of scale (reduces per unit costs)

  • government policies and support (trade, agreements, subsidies, etc)


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limitations of comparative advantage

  • over dependence

  • environmental degradation

  • distribution of income

  • structural unemployment

  • flawed assumptions