National Welfare Effects of Free Trade in the H-O Model

The adjoining diagram compares autarky and free trade equilibria for the US and France.

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 I_Aut.

The US production and consumption points in free trade are P and C, respectively. In free trade the US realizes a level of aggregate utility which corresponds to the indifference curve I_FT. Since the free trade indifference curve I_FT lies to the northeast of the autarky indifference curve I_Aut, 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 I_Aut*.

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 I_FT*. Since the free trade indifference curve I_FT* lies to the northeast of the autarky indifference curve I_Aut*, 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.

However, the use of aggregate indifference curves (or preferences) ignores the issue of income distribution. Although it is correct to conclude from this analysis that both countries benefit from free trade, it is not correct to conclude that all individuals in both countries also benefit from free trade. By calculating changes in real income in the H-O model it can be shown that some individuals will likely benefit from free trade while others will suffer losses. An increase in aggregate welfare means only that the sum of the gains exceeds the sum of the losses.

International Trade Theory and Policy - Chapter 60-10: Last Updated on 7/31/06