International Trade Theory and Policy
by Steven M. Suranovic

Trade 120-2

Economic Efficiency Effects from Free Trade

The main source of support for free trade lies in the positive production and consumption efficiency effects. In every model of trade there is an improvement in aggregate production and consumption efficiency when an economy moves from autarky to free trade. This is equivalent to saying that there is an increase in national welfare. This result was demonstrated in the Ricardian model, the Immobile Factor model, the Specific Factor model, the Heckscher-Ohlin model, the Demand Difference model, the simple Economies of Scale model, and the monopolistic competition model. Each of these models shows that a country is likely to have greater national output and superior choices available in consumption as a result of free trade.

Production Efficiency

Improvements in production efficiency means that countries can produce more goods and services with the same amount of resources. In other words, productivity rises for the given resource endowments available for use in production.

In order to achieve production efficiency improvements resources must be shifted between industries within the economy. This means that some industries must expand while others must contract. Exactly which industries expand and contract will depend upon the underlying stimulus or basis for trade. Different trade models emphasize different stimuli to trade. For example, the Ricardian model emphasizes technological differences between countries as the basis for trade. The factor-proportions model emphasizes differences in endowments, etc. In the real world it is likely that each of these stimuli plays some role inducing the trade patterns that are observed.

Thus as trade opens, either the country specializes in the products in which it has a comparative technological advantage. Or, production is shifted to industries which use the country's relatively abundant factors most intensively. Or, production is shifted to products in which the country has relatively less demand compared with the rest of the world. Or, production shifts to products which exhibit economies of scale in production.

If production shifts occur for any of these reasons , or for some combination of these reasons, then trade models suggest that total production would rise. This would be reflected empirically in an increase in the country's gross domestic product (GDP). This means that free trade would cause an increase in the level of the countries national output and income.

Consumption Efficiency

Consumption efficiency improvements arise for an individual when changes in the relative prices of goods and services allows the consumer to achieve a higher level of utility. Since the change in prices gives the consumer a choice that he did have before, we can say that consumption efficiency improvements implies that more satisfying choices become available. When multiple varieties of goods are available in a product category then consumption efficiency improvements can mean that the consumer is able to consume greater varieties or is able to purchase a variety that is closer to his ideal.

Although improvements in consumption efficiency are easy to describe for an individual consumer it is much more difficult conceptually to describe it for the aggregate economy. Nevertheless when aggregate indifference curves are used to describe the gains from trade, it is possible to portray an aggregate consumption efficiency improvement. One must be careful to interpret this properly though. The use of an aggregate indifference curve generally requires the assumptions that, 1) all consumers have identical preferences and 2) there is no redistribution of income as a result of the changes in the economy. We have seen however, that in most trade models income redistribution will occur as an economy moves to free trade. It is probably also likely that individuals have different preferences for goods.

International Trade Theory and Policy - Chapter 120-2: Last Updated on 7/19/97