International Trade Theory and Policy
by Steven M. Suranovic

Trade 40-9B

Aggregate Welfare Effects of Free Trade

The adjoining diagram compares autarky and free trade equilibria for the US and France. The US PPF is given by the red line while France's PPF is given by the green line. We assume both countries share the same aggregate preferences represented by the indifference curves in the diagram. Note also that if the US and France had the same size labor force then the relative positions of the PPFs implies that the US has the absolute advantage in cheese production while France has the absolute advantage in wine production. Also, if each country has an absolute advantage in one of the two goods then each country must also have the comparative advantage in that good. Can you prove this??

The US autarky production and consumption points are determined where the aggregate indifference curve is tangent to the US PPF. This occurs at the point A. The US realizes a level of aggregate utility which corresponds to the indifference curve IAut.

The US production and consumption points in free trade are P and C, respectively. The US specializes in production of its comparative advantage good but trades to achieve its consumption point at C. In free trade the US realizes a level of aggregate utility which corresponds to the indifference curve IFT. Since the free trade indifference curve IFT lies to the north east of the autarky indifference curve IAut, national welfare rises as the US moves to free trade.

France's autarky production and consumption points are determined by finding the aggregate indifference curve that is tangent to the French PPF. This occurs at the point "a". France realizes a level of aggregate utility which corresponds to the indifference curve iAut.

French production and consumption points in free trade are "p" and "c", respectively. In free trade France realizes a level of aggregate utility which corresponds to the indifference curve iFT. Since the free trade indifference curve iFT lies to the north east of the autarky indifference curve iAut, national welfare rises as France moves to free trade.

This means that free trade will raise aggregate welfare for both countries relative to autarky. Both countries are better off with free trade.

International Trade Theory and Policy - Chapter 40-9B: Last Updated on 7/18/06

PREVIOUSNEXT