Internation Trade and Economics

International trade is a very important topic in economic studies. Let's examine the basic terminology and concepts of international trade.

World price is the price that prevails in the world market of a good. If the world price is higher than domestic price, the country will benefit from exporting. If the world price is lower than the domestic price, the country will benefit from importing. Domestic price is similar to opportunity cost of a good. The higher the domestic price, the higher the opportunity cost and the lesser comparative advantage over other countries.

For the next analysis we will assume that Country A is a small country that it takes the world price and will not affect the world market with its trade policies.

A's domestic price of lumber is lower than the world price. When free trade is allowed, A's lumber producers immediately raise the price to equal to world price because no producers will accept prices lower than world price while no buyers will accept prices higher than world price. Thus, the export of lumber of Country A will be the difference between its domestic supply and domestic demand at the world price.

Winners: domestic producers because they sell at a higher price;
Losers: domestic buyers because they have to pay more for lumber.

Moreever, total surplus in Country A rises. Consumer surplus drop from the triangle between Price 17 (Price before trade) and Demand Curve to Price 25 (Price after trade) and Demand Curve. Producer surplus, however, expands from the triangle between Price 17 and Supply curve to Price 25 and Supply curve, not only engulfing the lost consumer surplus but also gaining the area in between supply and demand curve beneath Price 25 due to exports.

Country B is a lumber importing country b/c domestic price > world price. Domestic buyers are winners because they buy at a lower price (world price); domestic sellers are losers because they sell at a lower price.

Total surpluses of Country B also rises. Assume 500 is old domestic equilibrium price and 300 is new world price. Producer surplus drops from triangle between 500 and S to 300 and S. Consumer surplus rises from triangle between 500 and D to 300 and D, engulfing all losses of producer surplus and gaining area between S, D and 300 due to exports.

Free trade expands the economy but some (consumers in exporting nations and producers in importing nations) will get a smaller piece of the pie because of it.

Accordingly, free trade benefits its participants. But how these profits and benefits are distributed among them is another problem that economists study.